Hello all! Just when you thought it couldn’t get any wackier!? It did.
Several weeks ago, my son asked me if I had seen what was happening with GameStop, AMC and Blackberry stocks. My honest reply was, “No, but are those companies still in business?”
In “short,” (sorry I had to), small investors on a Reddit online community called WallStreetBets, organized a stock buying effort (via Robinhood a free trading platform), that resulted in driving up the stock prices of GameStop and other distressed companies. Some lucky small investors bought low and sold high to pocket an incredible, if not artificial, gain. However, the money sharks, particularly hedge funds got burned. How? They had “shorted” these stocks and got squeezed. In other words, they borrowed then sold the shares in anticipation of the stock prices falling further. But, shorting a stock is only profitable when the investor can buy back the shares at substantially lower prices, cover the short, and pocket the difference. In this instance, the short-sellers had to scramble to buy the stock at the inflated price to cover the short sale and to limit their mounting losses. And, the frenzied buying does what? It drives the stock price even higher.
GameStop alone rose more than 14,300%—surely some kind of record for a firm whose market share is eroding and which most analysts think is clinging to an outmoded business model. (The company sells video games through bricks-and-mortar retail outlets in a world where everything can be downloaded.)
GameStop’s 52-week low was $2.57. Its 52-week high was $483.00. The stock was at $65 on January 22; and finished January 29 at $325 per share.
The hedge funds, meanwhile, lost an estimated $5 billion on their bets; roughly $1.6 billion on January 29, when GameStop’s stock jumped 51%.
What the financial media neglects to mention is that this activity is not investing; it is, instead, a form of gambling, and the story tells us a great deal about the mindset of many retail investors these days.
Toward the end of every bull market cycle, there is an invisible line that is crossed, when the public starts to think of the stock market, not as a way to share in the growth and profits of public enterprises, but as some kind of roulette wheel where the ball always seems to stop on a higher price. These share owners cease to be long-term investors, and prices are bid up not based on the underlying value of the companies, but on the expectation that whatever you buy, at whatever price, someone else will come along and pay a higher price.
Of course, markets only work that way for a short time, typically at or around market tops. Eventually, the share prices of GameStop, AMC Entertainment Holdings and Blackberry—and perhaps many other stocks that are being gambled with at the moment—will return to something that more closely resembles the real value of the real company. Long-term investors have tended to win the kitty over every past historical time period, while gamblers have seen their short-term winnings evaporate in the ensuing bear market.
Here’s a few lessons to remember after a stock frenzy:
- Speculating vs. Investing – There is nothing wrong with speculation, just don’t get it confused with investing. “Speculation is an effort, probably unsuccessful, to turn a little money into a lot. Investment is an effort, which should be successful, to prevent a lot of money from becoming a little.” — Fred Schwed Jr.
- FOMO: Fear of Missing Out is a powerful emotional driver of investment decisions.
- Diversification and Planning – Concentration can make you rich, diversification can keep you rich.
- The goal of planning is to enhance wealth that you have created from your labor and consistent investing, it isn’t to create wealth through speculation.
- When there is uncertainty, and there always is, a proper plan, risk specific portfolio, and diversification are your friend for reaching your goals.
My son, who has a Robinhood account, asked if I thought he should buy some GameStop stock. No, I replied, this is a bubble that will soon burst. However, it is almost a moot point, as trading the stock has been disrupted or even suspended on multiple trading platforms. Crowd trading will surely get an examination by the Securities and Exchange Commission. And, it is tax season, a slew of novice speculators may get a hard lesson on the taxation of short-term vs. long-term capital gains and the “wash-sale rule.”
On the surface, this story has a David (small retail investors) slays Goliath (big hedge funds) element to it, but the real story is our propensity to repeatedly get drawn in to the get-rich-quick mentality. (Heavy sigh.)
Stay safe and be patient.
QUESTIONS?
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