“The longer you’ve been around, the more you realize that something like this is less a massive break in the functioning of markets and more a reflection of risks that were always there,” says Michael Cembalest, the chairman of market and investment strategy at JP Morgan Asset Management. Manias have been parts of markets for centuries. So have short squeezes. And in this case, the hedge funds betting against GameStop might have received just deserts for a really dumb bet.
As a matter of practice, the best strategy for short sellers is typically to identify ostensibly good companies with an Achilles’ heel. You take a position when the firm’s stock is high. Eventually the market finds the weakness you’d identified, and then the stock falls, at which point you make a bunch of money.
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But GameStop for the past year has been the opposite of all that. It was a bad company, whose stock had already fallen from $56 a share in 2013 to about $5 in 2019. GameStop’s short sellers were essentially betting that a company publicly valued as “horrendous” should really be valued at a level commensurate with the notion of “truly horrendous.” They risked billions of dollars on the financial equivalent of a qualifying adverb. It’s really risky to aggressively short a company whose stock, having fallen 95 percent, is floating around $5; there just aren’t a lot of numbers under five. Plus, companies in GameStop’s situation can always try to restructure their operations, or appeal to a white knight, or exit the business and sell off their commercial real estate, or do something else when the cost of capital is basically zilch.
What’s new here is the presence of Reddit and Robinhood. The GameStop trade briefly conquered the world by taking advantage of two things the internet does very effectively. First, the internet is really good at manufacturing upstart sects, for good and for evil. You can despise the Capitol siege of January 6 (I do) and adore the GameStop surge of January 26 (I’m undecided), but still see something in common: two anti-institutional plots conceived in online message boards, amplified on broader platforms such as YouTube, and actualized, chaotically, in the real world. Tens of millions of people in this country who are soaked in the attention economy are, apparently, eager to throw their weight behind some 15-minute-famous cause, and it’s not always straightforward from the onset which ones are safe and virtuous and which ones are not.
Second, the internet democratizes access to information and communication—again, for good and for evil. “Retail investors with the help of technology acting as a union in attacking is a new phenomenon,” Jim Paulsen, an investment strategist, told CNBC. “You combine the power of technology, which allows you through Reddit postings to magnify your individual impact, with some use of leverage and very targeted bets, [and] they can have a significant influence.” That’s right, but the democratization of finance is, like the democratization of everything, a rose with thorns. GameStop’s stock has soared, not in response to its economic fundamentals, but in proportion to the number of people paying attention to it.