It’s a sunny day when lil ole Robinhood’ers carry home some crumbs of victory. The events of this week reverberated across financial journals and left some billionaire bosses red faced, having to explain to their clients how a little known corner of the internet delightfully named ‘WallStreetBets’ lost them in excess of $3 billion.
It was a powder-keg 2 years in the making and a sign of what is to come. Many in the media, your CNBC, your WSJ will decry it as an act of chaos – a sign of the market gone mad, of irrational exuberance, but that’s only because it is their (very private) world that is burning. The events of last week which saw GameStop ($GME) rise 84%, leaving short funds with in excess of $3 billion in losses, are a cultural moment where retail traders humbled the ‘Market Wizards’. My aim in this short diary is to give you a counterbalance to the main stream narrative that will inevitably rage after this ordeal is over.
In essence, what happened last week was good. What happened last week was fair. What happened last week was the functioning of a proper shareholder democracy.
Beaten down & but not out
GameStop is a brick and mortar retail store that was losing customers, losing money and losing hope. Its shares on the stock market were heavily shorted (where market actors make money through the stock dropping) and had been driven from a high of $56 to a low of less than $3 by April 2020. With a rapidly declining price, deteriorating financials and a secular decline in the retail sector, expectations were of delinquency and bankruptcy and such is how the story would have gone if it had not been for some eagle eyed investors.
Michael Burry, the Big Short guy, saw the low hanging stock and spotted a mis-pricing, at ~$3 the stock was trading far below its book value, the net price of its assets and hence could be trading much higher than it was. It was beaten down for sure but who isn’t. He started purchasing and by May 2019 owned 2.75 million shares (3.04% of the company).
One of the greatest value investors of our generation had thrown his weight behind the company. Suddenly there was a resurgence of interest and many other investors started looking under the hood; Rod Alzmann who popularised the stock on Twitter, u/DeepFuckingValue aka. Roaring Kitting (check out his YouTube Channel) also took what would be a monetarily small for now but culturally significant stake with $50,000 of call options. With a renewed enthusiasm we had a potential comeback story on our hands. The stock started trending up. This was bad news for short sellers whose money printer had just hit a jam. But they persisted, battling it down through increasing their short positions, which kept getting larger and larger.
Enter Ryan Cohen – he is a poster CEO, your girlfriend would leave you for him and your father wished he was his son. He had bootstrapped Chewy, an e-commerce pet food retailer, into a $4 billion behemoth, beating Amazon at their own game. Through his activist fund Ryan started building a substantial stake in GameStop through the summer of 2020 and speculation of his involvement sent the stock surging. With a talented CEO on board, GameStop could transform itself from a BlockBuster style retailer into an Amazon style e-commerce company, creating a powerful niche in the online gaming sector. Hope was rising, shorts were hurting, Hans Zimmer comeback music had started playing.
This is when the first significant wave of retail investors started taking interest. u/DeepFuckingValue’s audacious investment had started generating interest in GME on the online discussion forum, ‘WallStreetBets – its as if 4Chan found a Bloomberg Terminal’. Some of the top ranked posts on the forum are as follows:
· ‘Gold Standard < Big Mac Standard’
· ‘I will invest $100,000 into whatever is the top reply’ – its long term chairs in case you were wondering - yeah dont ask me why.
· ‘I said if SPY (a popular stock index) closed green today, I would drink my pee. Here is the video’ – the guy lives in a basement where he pees into a drain a metre away from both his desk and bed. Into a martini glass though, gotta keep it classy.
· ‘Upvote to Ban all of Canada from the Internet’
The most common fear in the forum is of appeasing their wife’s boyfriend & CCP infiltration. There is also a cyclical passion for investment in gourds. Im serious.
I tell you this to make it clear, these are slightly weird people (typically male aged 18-45) who just want to have fun on the internet under the guise of anonymity. The forum has grown to 2 million members and whilst most are the ‘throw it on red’ types, amongst them lie some true genius. Every so often there is a thesis posted that is compelling, that is blindingly obvious, that dominates the subreddits attention and energy. A while ago it was Gold, before that steel and before that I believe corn futures were the rage.
After u/DeepFuckingValue’s post some of the more literate members of the community started talking about GameStop. The arrival of Ryan Cohen, the target market being online gaming – congruent with the subreddit demographic, had created a cocktail of a turn-around story that the people had an edge on - most people on the sub are gamers and could understand the potential of the GME opportunity. A wave of buying commenced.
This is where it becomes important to note that literacy has very little correlation with wealth in this community; some chucked $1,000 some $10,000 and a couple of iron balls placed $1,000,000+ bets on the future of GME. As the stock price rose and the evidence of these early successes started filtering through (people commonly post their gainz on the forum) more people piled in.
George Soros has a theory of reflexivity of stock prices and the underlying company – with a higher stock price and market cap, pathways become open to a company that were not available before. Tesla is a great example of this. With a higher market cap a company can engage in new M&A transactions, issue new shares, borrow against the equity and actually invest in making the underlying company significantly better. The same phenomena was now possible with GME. With a rising stock price, a poster CEO, positive momentum and reflexivity the stock started accelerating. From $13 in December 2020 the stock hit $30 in early January 2021. Remember all those shorts? They had kept increasing their positions as they did not appreciate Soros’ view and were convinced GME was a BlockBuster waiting to happen, but they were already bleeding.
Every day the stock rose, every day their losses rose and when it breached $45 on the 19th of January, famous short seller and now red-faced Citron Research proclaimed this was all a mania and they would release a 5 point video the next day explaining why GME should be at $20. WallStreetBets responded by reminding the firm of all their previous wrong calls but there was a spook, the stock fell to $38, could we all really be wrong?
The next day, anticipation built and on the expected time of release Citron announced they had forgotten there was a Presidential Inauguration to be had and they wished not to disturb the moment. If only someone could have told them!
It was clear, something was amiss.
They postponed their video till the next day and when it was released there was a collective sigh of relief. The analysis was lazy and the community had already anticipated each point and come up with better arguments than the research firm had presented.
The video also reeked of arrogance as he accused GME investors of being ‘pizza boys’ who knew far less than he did. Sure.
The stock rocketed to $75 the very next day. Short sellers lost billions and the pain is not yet over.
How could this happen?
Historically markets have been hideously unfair for an average wage investor. They must pay high fees placing a barrier to entry and are priced out of market research reports limiting their insight. A Bloomberg terminal, the toolkit of every Wall Street trader costs in excess of 20,000 GBP annually. However over the last 5 years this inequality has been reduced.
Robinhood, for all its faults, has allowed retail to trade commission free and the nodes of decentralised knowledge networks such as Twitter & WallStreetBets has allowed the spread of sophisticated, well informed analysis. Whilst it is up to the individual investor to separate the cash from the trash, the fact that high quality analysis is now easily accessible for free has enormously levelled the playing field. Moreover through these same social networks, people can discuss their fears, temper their wild dreams and collectively come to more informed decisions regarding their investments.
This is troubling for Wall Street. It has thrived and lived off ‘dumb money’. When ‘dumb money’ gets smart their jobs get hard. When ‘dumb money’ gets big, they start getting scared. What was remarkable about the GME phenomena is that millions of small investors stuck to a thesis through thick and thin; the price volatility (instigated by the short sellers to create fear) could have scared off the paper hands but the collective security of a reassuring community turned that paper into diamond. Every single day a barrage of fresh memes were published reassuring the community of their thesis and quelling fears. Remarkable videos, voice overs, mix tapes (including a Sea Shanties remix), novellas were all written to keep the community spirit. Half of the success in a trade is having the conviction to see it through and the online communities provided exactly that.
It fundamentally changed the playing field. It made ‘dumb money’ smarter, it made retail collectively powerful and it gave them the conviction to see the trade through. It violently upsets the status quo and makes Wall Street traders work harder. It reduces their edge and hurts their bottom line. This will not sit will and there will be a reckoning. Accusations of market manipulation, of paternalistic concern will be made. They are PR speak for ‘they took our money and we want it back’.
But there is a legitimate concern
A collective hive mind of millions of people gambling on sophisticated financial products could lead to damage if it all goes wrong. This is entirely possible and as with every gainz post there is also loss porn, where entire accounts have been wiped. Paternalistic concerns are however not sufficient reason to regulate these products away from retail investors.
Retail traders have as much right to trade as sophisticated analysts do. As we saw from the Citron video, the quality of knowledge difference is not as stark as Wall Street makes it out to be. Losses made on the financial markets are the responsibility of those who made the trade, the decision making and accountability should be borne by the individual. We do not prohibit sports betting, nor horse racing betting, why are financial products different?
One may argue it upsets the efficient functioning of financial markets! I can only laugh at this assentation. We live in an era where price discovery is dead, risk of failure has been supressed and stock values and company health are more likely to be inversely correlated. The real subtle hint behind this Wall Street argument is that we ought to have the monopoly power in exploiting this QE binge and that if retail wants to have a slice let them gnarl at each other, not at our expense.
As for the funds that got blown up? I feel for anyone who hones their craft and loses but this is part of the risk management process. If you short an illiquid stock beyond the available float and refuse to recognise a comeback story of a lifetime and then refuse to exit the trade for months despite evidence against your thesis then you deserve to sell/buy at the market price. When arrogance over rides risk management and you short 140% of the available float what do you expect? Too big to fail? No, you’re not a bank.
The blow up of hedge funds following this disaster will also have long term ramifications for the industry. For the last ten years the majority of funds have continued to underperform the simple S&P 500, for these last ten years they have consistently lost money to passive funds. More concerning for them, every day they get ridiculed by teenagers online they lose the mystique that gave them their power.
This is not to side sweep at all of them – many people in the industry are the smartest people I have ever met but the industry is too large, too full of average people looking for prestige validation, every day they linger, retail will eat their lunch.
As of 27/01 11:05 GMT Pre Market Price is $340; Melvin Capital & various other funds are close to liquidation. The situation has exploded into a cultural and macro financial phenomena which I am diarising for v1.3 of this saga. Sign up for the update.
28/01 13:47 GMT $449