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The Big Short Squeeze

Nicholas Earl, 08/02/2021

During its retailing heyday, while servicing the early millennium console boom and mass expansion of the personal computer, most of GameStop’s customers considered its slogan, ‘Power to the Players’, to be little more than a statement of unintentional irony rather than a meaningful mission declaration.

Alongside fellow physical media titans such as Blockbuster which had also authoritatively stamped its name into the collective consumer consciousness of American shoppers, the bricks and mortar electronics chain did not have a great reputation for customer service.

Over-priced, under-staffed and with highly officious trade-in policies, there was rarely any time during its peak years that GameStop’s customers considered themselves to be empowered denizens of disc media, frequenting their favourite store the same way one might regularly return to their preferred coffee shop, cheese market, or indie record store. By contrast, it was their place of purchase mostly out of necessity with GameStop gobbling up the competition.

When Blockbuster met its demise in 2010 at the hands of streaming platforms, many commentators reflected on what this might mean for disc media, but very few people shed a tear for the chain’s closure itself, and until recently GameStop’s deterioration from a mainstay in mega-malls and retail parks across the entire breath of North America to a loss-making enterprise undergoing a period of managed decline was hardly a topic of great mourning.

In the past month however, it has morphed into a topic of great opportunity.

After retail investor DeepF***ingValue (real name: Keith Gill), a popular user on the sub-reddit r/wallstreetbets, successfully generated interest in the continuous shorting of GameStop’s position on the stock market, and covered the topic extensively in YouTube videos under the alias RoaringKitty, the obsolete gaming store enjoyed an unexpected second life.

Fittingly self-described as ‘Like 4Chan found a Bloomberg terminal’, the meme-friendly, business savvy r/wallstreetbets community of then approximately two million members observed on 22 January that 140 percent of GameStop’s public float had been sold short, leaving institutional investors at hedge funds unusually exposed. Initiating a short-squeeze through a mass purchasing of the stock largely through the Robin Hood app, the price of GameStop (ticker symbol: GME) rose rapidly from $65.01 to $347.51 five days later on January 27, eventually climaxing at over $500. This was 30 times its value of $17.25 at the beginning of the month. In the time since, r/wallstreetbets has grown to 8.7 million members.

On January 28, Melvin Capital was reported to have lost 30 percent of its value since the start of 2021, having heavily invested in shorting the besieged video game retailer. The investment fund lost approximately $4.5 billion in assets. Around 5,000 firms suffered loss-making short positions, topping $70 billion in total. A flurry of activity followed with other shorted stocks such as AMC Entertainment Holdings (AMC), Nokia Oyj (NOK) and BlackBerry Limited (BB). A combination of millennial nostalgia for products remembered more fondly in hindsight, investment acumen and social media meme culture generated a tidal wave of disruption to some of the biggest firms on Wall Street.

For perhaps a week in late January, with institutional investors in retreat, GameStop had lived up to the ideals of its marketing slogan.

Since then, GameStop’s share price has declined to $63.77, with much of the narrative already dissected and analysed by the entire breadth of business media. Mr Gill’s brokerage accounts currently hold $33 million (down from a $48 million high) after an initial $53,000 investment, while several hedge funds and institutional investors have benefitted from the situation with Senvest Management making a $700 million profit from a five-percent stake purchased when shares were at $10 each, while BlackRock enjoyed a peak of $2.6 billion on its 13 percent share.

It is unclear how many Reddit users and bandwagon hopping retail investors who bought shares will benefit from GameStop’s outperformance, and extensive debate lingers around the closing of the community’s Discord platform and Robin Hood’s decision to first prevent and then limit the purchasing of shares in GameStop while permitting sales. This event has been deeply saturated with analysis from across the media, on the implications for Wall Street, on the ramifications of Robin Hood interfering with retail investor strategies, and on the intriguing Reddit group that created the short squeeze.

What also needs to be assessed however, is the implications for retail investors generally and whether this reflects their growing power in the industry. Are short squeezes a sustainable measure for retail investors from the complacency of institutional strategies?

Russ Mould, investment director at AJ Bell, believes that institutional investors are going to have be more wary of these kinds of actions from retail investors in the future.

Speaking to Fundeye, Mr Mould outlined that hedge funds had acted complacently.

He said: “No matter what their conviction levels about GameStop’s business model, finances and valuation, they should have realised that aggregate short positions against the stock meant they have an illiquid position that could be hard to close even if it went well. It also left them exposed to a classic short squeeze by other hedge funds, let alone the one we have just seen.

The investment director also argued that the episode highlights the importance of retail investors having a clear strategy during a short squeeze, including a planned route out of an investment.

He felt that while social media campaigns could provide retail investors with new possibilities and strategies, the fundamentals of investing were the same regardless of the size of any online bandwagons.

He explained: “Such campaigns can be a danger and an opportunity – the two go hand-in-hand. There is no reward without risk and vice-versa. They key is to manage that risk and ensure that the potential rewards more than compensate for the dangers. Just like all investors, retail investors therefore need to have a plan.”

Mr Mould noted that any plan needed to include key factors, such as the reason why someone is investing, what their target returns are, what their time horizon is, and what their appetite for risk is.

He added: “Fear of missing out can lead any investor to depart from those disciplines and take on more risk than would normally be the case. That’s what accidents happen and trouble begins – and trouble in portfolio terms is loss of capital on a permanent basis.”

Tommy Faber and Charles Jones, fund managers at Waverton Investment Management (Waverton), felt that the ‘little guy’, the retail investor, has been increasingly marginalised in shareholder events and AGM/EGM meetings across the industry, which has had decreased board room accountability as it is increasing difficult to ask executives questions directly. Consequently, retail investors can maximise their ability to influence investment processes by banding together.  

They compared GameStop’s outperformance through a co-ordinated short squeeze to the revolt from BP shareholders revolt against executive pay in 2016, where they voted down renumeration packages they deemed excessive. In this sense, it was really a continuation of a shift happening away from web-browsers and meme-filled forums, with investors banding together to make their influence known against elusive authorities. 

They said: “The key to changing a company’s direction is the ability to aggregate enough small shareholders to make a material difference. Since the retail investor often isn’t the legal owner of the shares (the nominee is), they cannot control board rooms in this way. Instead, they must aggregate on social media and try to force a company’s PR team to take note of their views.”

Commenting on the possibility for success, they added: “PR teams are more likely to respond to emotive and negative communications, frequently harming the share price that the owner is usually trying to increase and can be counterproductive. Given this, the ‘little guy’ has the greatest chance of changing the company by being a customer, working with other customers on social media.”

Nevertheless, Waverton’s fund managers shared Mr Mould’s viewpoint that the risk from anti-establishment investment behaviour perpetuated by a Reddit page provided plenty of pitfalls alongside opportunities. In particular, hearsay of great returns could lure retail investors into decisions they will later regret. While some retail investors will benefit from GameStop’s outperformance, more will be left in possession of highly unattractive shares, sold at a price significantly lower than desired, when the game of pass-the-parcel eventually stops.

They said: “It is easy to get sucked into trades when you hear all the examples of retail investors making £5,000 in a week. However, when the dust settles and the technical dynamics have corrected which they will, and have to some degree already as seen by GameStop’s precipitous fall from $348 to $90 in two days, investors will be left holding the underlying shares or in the case of options trading, worthless contracts if they are not careful.”

This was especially the case because, crucially, short-selling did not actually change the fundamentals of GameStop’s business and the unanticipated cash flow was unlikely to enhance its long-term prospects.

Mr Faber and Mr Jones outlined that the management teams of cult stocks on Reddit were selling their positions. They also cited Benjamin Graham’s conception of the market, noting that in the short-term is a voting machine, assessing the popularity of stocks, but in the long-term is a weighing machine that assesses them on a substantive basis. The long-term trends for GameStop, could not be arrested by a short-squeeze while the potential to really damage institutional investors or make significant amounts of money were limited.

They said: “It is certainly possible to make a quick buck trading these stocks but as soon as the market refocuses on fundamentals, the timing of which is impossible to determine, the inevitable conclusions will be drawn.”

Mr Mould echoed this perspective, observing that while Redditors had caught hedge fund managers off-guard, the share price gains were at best ‘transient’.

A more critical vantage point was offered by Dr Richard Smith, chief executive officer (CEO) at The Foundation for the Study of Cycles. While he raised concerns about Robin Hood’s decision to limit people buying shares for an extended period of time, and felt that wider questions needed to be asked about its role in retail investing and how it profited from users, the real buck stopped with the investors themselves.

He felt that the GameStop outperformance, created by the ‘crowdsourcing’ of a short squeeze only emphasised the casino-like nature of the market with people gambling on a whim, before The House finds a way to win. While complimenting early participants who observed a weakness in the architecture of the market, he believed that these kinds of short-squeezes were not reflective of real retail investing.

Dr Smith argued: “I don't think that they are representative of the vast majority of people who could have a constructive, healthy long-term relationship with the capital market. The average person out there who could be an investor is not going to be like Roaring Kitty. He shouldn't be held out as the exemplar for the retail investor. That’s a disaster.”

The CEO believed that the revival of GameStop’s share price, alongside multiple unfavoured stocks represented a legitimate disenfranchisement and grievance against institutional investors, and the advantages that they have over retail investors, but that it would ultimately result in more pain for retail investors. He expected that very few investors out of the millions that joined in with buying GameStop shares, would benefit financially from the arrangement.

He added: “There'll be a few people from r/wallstreetbets that got rich. There will be a Netflix movie made about them, and the public will go on thinking that this is somehow a legitimate way to be successful in the market, and it's not. For the majority of the people retail investors that participated, it was a way to give their money to the institutions and hedge funds.”

Commenting on what retail investors needed to do in the future to constructively show their influence, Dr Smith argued that people needed to educate themselves and realise that when something seems ridiculous, it probably is.

He said: “A stock that is one day was worth $40, and one week later is worth $300, and you're buying it because you think it's going to go to $1,000? There’s no universe in which that makes sense, at a rational level. If you want to chalk it up to entertainment, part of r/wallstreetbets is have fun. You paid your interest to have some fun, and as long as you do that with an amount of money that you're willing to pay for entertainment? Great. Don’t call it investing, though.”

Mr Faber and Mr Jones noted that retail investors would also struggle to replicate their success across other stocks and shares beyond the initial selection they targeted last month due to the general lack of shorted companies.

They said: “For certain hedge funds, it probably will be more important to monitor social media for signs that retail investors are colluding to create a short squeeze. However, the number of crowded shorts is few and far between with just 94 US companies with more than 20% short interest/float. This doesn’t include off exchange short positions so the true number may be higher. If hedge funds avoid crowding, it will be hard for retailers to repeat the GameStop success.”

Consequently, while retail investors might have shown their potential level of influence over the market, and exposed careless hedge fund managers overcommitting to shorting a stock, it is unclear whether they can successfully implement short-squeezes with social media campaigns in the same way Redditors inventively managed to do so last month. Instead, retail investors might have to play a longer game, looking to pool their influence through a more gradual process, avoiding the undeniable excitement a short squeeze can provide.

Reflecting on the state of the industry, Mr Mould concluded: “I don’t think anyone can or does or wants to view financial markets as a closed shop for professional market participants only. Nor will fund managers view the volatility with concern – they will welcome it, as such price action provides active managers with a chance to add value and take advantage of wild movements by selling high and buying low, the same as any other trader or investor.”

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