GameStop: A Real Life Video Game

We’re a weekly Wall Street wrapup, so we’re compelled to weigh in on GameStop (NYSE: GME). First, let's explain a short-sell, and try to understand what happened. Here’s how a short-sell works. An investor believes a stock (i.e. GME) is going down because the business is, well, just a bad business. To take advantage of this position, the investor can’t just buy shares (that would be a long position). They want to make money as the stock drops. So, here’s what they do.

They borrow shares from a friend (or a broker or a fund etc). Say 10 shares for $100 each = $1,000. They immediately sell those shares in the open market and pocket the $1,000. Then, when the price of GME drops to say $5, they buy the shares in the open market, but now they get the whole lot for $500 ($5 / share times 100 shares). They then deliver the shares back to the owner. The owner gets their shares back and the investor makes a profit of the difference ($1,000 received from selling the shares minus the $500 they paid to buy the shares in the open market to deliver back to the owner). But this goes horribly wrong sometimes. If the share price goes up instead of down the investor could lose bundles of money. So, say those shares went to $20 a share. The investor would have to buy at $20 x 100 shares = $2,000. Now the investor returns the shares to their rightful owner but just lost $1,000. So, that’s what happened with GameStop. The company hasn't performed financially well in years. Many billionaire hedge fund investors shorted the stock. But the loyal actual customers (who buy their video games at GameStop) didn't want to see the company go out of business. So they all got together (in internet groups) and started buying small lots of shares in the company. This drove the stock price up. In the meantime the short sellers had to start buying the shares to stop their losses. And this gets into a vicious buying cycle driving the stock price higher. Ultimately the short sellers lose lots of money. In the case of GameStop it was the internet (the thousands of small retail buyers in small lots) against the massive billion dollar hedge funds that shorted the stock. The internet, as we have all come to see, almost always wins. Nothing beats a crowd. This GameStop situation has nothing to do with the health of the market generally, and its stock price is 100% disconnected from the true value of the company. At some point this stock will plummet back, but who knows when. That’s why we suggest you always just buy good companies. So, Are We in a Bubble Like 2000?

GameStop and "short squeeze" became household names overnight, as the stock of the video-game retailer skyrocketed and the narrative around small day traders versus massive hedge funds captured what seems 100% of market news this week. If history predicts the future, GameStop will not repeat its share-price ascent indefinitely, nor will it remain the driving force behind the overall stock-market. We do, however, think it represents a broader condition of the market, one in which speculation and animal spirits have produced abnormal returns in certain investments. So does that mean a bubble? No. Should this be ignored? The GameStop fury signals a level of animal instinct in the market that will likely contribute to more frequent bouts of swings, producing a choppier path compared with the market's smoother sailing over the past several months. GameStop speculation doesn't make a market top: Last July, Eastman Kodak rose 1,400% in three days amid speculative buying. Yeah, that Eastman Kodak, the camera company that most people thought went out of business years ago. Just two years ago, amid the craze over marijuana stocks, Tilray spiked 1,100% in eight weeks. Bitcoin is up over 700% since March. These are narrow speculation moves. The wider market is not acting irrationally. That is, the market generally appears to be exhibiting little of the same froth that the headlines grabers make. Concerns of excess speculation, along with routine rebalancing or profit-taking after the stock market's strong rally, may contribute to the renewed volatility. But markets will do what markets typically do over time – re-anchor to the economy and corporate earnings - both of which look promising save hiccups for vaccines rollout challenges and swings in unemployment. Don’t let GameStop scare you. Understand it.

And that's your one minute weekly market scoop.

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