Headlines abounded this week about GameStop, Reddit's WallStreetBets forum, and retail investors vs. hedge fund managers. It can be enough to make your head spin. Let's clear things up by digging into five myths surrounding the shorting controversy.
Myth #1: David and Goliath
There is a David-and-Goliath, underdog-type of story going on regarding Game Stop. It is about retail investors using the Robinhood app to coordinate through social media. They've just defeated the Goliath, hedge fund Melvin Capital, with the stone of the short squeeze on Game Stop. It's a fun story, but I would say that this is a myth.
There are many more players behind the scenes in this narrative. It's not just Robinhood investors. Let's dive deeper.
Short Selling Stocks
Before we really can understand the story, it's essential to understand what short selling is. To review: When you buy low and sell high, you can make money in the stock market. You can do the exact opposite where you sell high and buy low, and if they're the same dollar amounts where you sold and purchased back, you're going to net the same amount of money.
So, what does it mean when we say somebody shorts a stock? We have somebody that has the stock in their account, somebody that wants to sell it short, and you have the broader market. Here are the five steps:
A short seller borrows the stock.
The short seller sells the borrowed shares at the current market price.
The stock decreased in price as anticipated.
The short seller buys back the stock at the lower price and pockets the net difference.
The short seller transfers the newly purchased shares back.
However, with GameStop, the steps looked a little bit different.
A short seller borrows the stock, GameStop.
The stock INCREASED in price going against the short seller.
The short seller buys back the stock at a higher price and loses the net difference.
The short seller transfers the newly purchased shares back.
Myth #2: Collusion between Hedge Funds and Robinhood
Another myth is that Robinhood and hedge fund Melvin Capital are conspiring behind the scenes.
The understanding is that it's the broker who sells the stock, and the collateral companies are having to post. With Robinhood, it could be increasing, and it's not that Melvin Capital made some calls to get this churn through. There is a company out there called DTCC, which is also NSCC. They're the clearing houses of clearinghouses.
They're the ones that are transferring the title ownership of a stock and making sure collateral is put up, and money is there. Everything that they do is to ensure an orderly market. The stocks you buy or sell will be transferred to the right owners, and the cash you gave up came into your account.
Myth #3: WallStreetBets Rube, Retail Investors
There's a myth that WallStreetBets is just a bunch of rube, retail investors.
However, if you were to Google Keith Gill and WallStreetBets, you would see an individual who's a CFA with a lot of experience running money for massive institutions. He works out of Massachusetts, and he's a significant influencer on his Reddit forum — that's right, WallStreetBets.
Influencers like Keith Gill, portfolio managers for a hedge fund, have a lot of market experience. They're going to go out and build their research to crowdsource using everyone's information through these Reddit channels, bringing together a good thesis. You have people following this and building their portfolio relative to these influencers' portfolios. Those are the early investors. Also, there are 2 million to 7 million people following that subreddit.
Myth #4: Wall Street as a Monolith
Another myth is that Wall Street is this giant monolith that is continually changing the game's rules.
The idea that Wall Street is one big block of people is not accurate. You have the IPO market where banks are going out to help companies get into the secondary market. They are a private company not trading on the exchange. They will also take it and go public, which is a vital part of the market process.
Then you have the investment bankers, people just getting market exposure, wealth management for the retail investor, real estate, etc. All of these players may be one person who's short and another person that's long, and they certainly will try to squeeze the other person. You may say this is just a game with no purpose; however, it does serve a purpose. Wall Street is vast, and there are many players with many different angles.
GameStop was just selling off, but we knew that this eventually would happen. If the only people buying the stock to push it up are the same people who will need to sell out of stock. If no one else wants to buy at these prices, the value will drop as there is no one to sell the stock at the current price.
On Feb. 2, 2021, it was down 60%, therefore trading below $100 for the day. We've probably seen the end of a high in GameStop, but that doesn't mean that it can't start all over again.
Let's say you were an investor in XRT, which is the CRT SPDR S&P Retail ETF. These are brick and mortar retail spaces. Through the secular trend going towards Amazon, COVID-19, the pandemic, and the lockdowns, it has been a beaten-down ATF.
As of December 2020, when the ETF had closed out, GameStop made up 1.58% of the position. With the run-up, you saw substantial gains in that index, but it was all GameStop.
As of Jan. 29, 2021, GameStop made up almost 20% of the underlying holdings. Therefore, if you were buying XRT, 20% of your proceeds were going into GameStop. This shows that you need to know what you own, which means you're becoming an active investor if you have to get under the hood frequently. This is part of the risk of that passive investing and how the passive investor could be participating in something that they don't intend to be.
The Reddit threads are now moving onto silver, and they're going to try to do another short squeeze.
It's far more difficult to corner the market. Some people can bring in silver, whether it's recycling, mining companies, or silver that you have at your home. There are many ways that silver can come into the market that just were not there for GameStop.
Myth #5: Everything is the Fault of Evil Speculation, which Serves no Purpose
If you want to find who's to blame for this, my guess is that it is the Federal Reserve with the amount of money they have created. We have $4 trillion of additional funds out there, which is causing extra money to slosh around to the point that if you go into those Reddit chains, you see they call them STEMI checks. My guess is that they took the money they received from the government and put it in the Robinhood account, and that's the money that helped them speculate.
Also, the Fed has stepped in time and time again. To help keep stock prices higher, they've talked about their money bazooka. There's a false sense of security that these prices will only continue to go up. The Fed's blame is because they continue to tilt "the field" in favor of higher equity prices. It is also pumping in a lot of additional money into the economy which,h may increase speculation in the market.
That's all on GameStop and WallStreetBets for now — but we'll keep you up-to-date on our Daily 3x3s and Wednesday Weekly Market Insights. Tune in daily at 5 p.m. CT and Wednesdays at 3 p.m. CT.
For this week's full market update, including news on President Biden's stimulus bill proposal, market movement, and interest rates, be sure to check out the recording on our YouTube channel.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results.
All indices are unmanaged and may not be invested into directly. The economic forecasts outlined in this material may not develop as predicted, and there can be no guarantee that strategies promoted will be successful.
All investing involves risk, including the possible loss of principal. No strategy assures success or protects against loss.
Securities and advisory services offered through LPL Financial, a registered investment advisor, Member FINRA/SIPC.
The fast price swings in commodities will result in significant volatility in an investor's holdings. Commodities include increased risks, such as political, economic, and currency instability, and may not be suitable for all investors.