Gamestop — who are the real winners ?
There are winners and losers in every battle, every game, every election. Who won the Capitol riot? Who won in Bernie Madoff’s ponzi empire? Who won in the great GameStop short squeeze?
History, logic, and some basic behavioral analysis can tell us with near certainty how the current GameStop fiasco will end. And when it does, there will be at least three different groups of winners and losers.
Those who got in early, made obscene profits, and got out will be the clear winners. They proved a point, however fleeting, and made big money doing it. They are posting their dream statements online for all to see and are ecstatic. They essentially won the lottery. None, however, could have predicted it would be as wildly successful as it was (including the investor who admitted to initiating the idea). They hit a gusher — no different from those who got in early on bitcoin, tulips or the early pioneers who drilled for oil.
Let’s not ignore their fortune — their luck, that is, not their money. Buying heavily shorted stocks (and particularly those being shorted for good reasons like poor fundamentals, poor management, or fraud) is a questionable long-term strategy for making money in stocks. You cannot easily predict which stocks will lead to a short squeeze or when the big short players will take their gains or losses and move on. When you do manage to buy into a stock that results in a short squeeze, you cannot know where or when the squeeze will end, and they tend to end rather abruptly. It’s a true game of chicken and a GameStop-style frenzy comes along extremely infrequently (like once in a lifetime). To believe that such a frenzy is now repeatable is folly.
The clear losers will be the hedge funds with heavy short positions who were forced to cover at big losses. Maybe one or two will even shut down. It comes with the turf. They’re big boys and they know the risks. They made a critical error in judgement by underestimating the power of the basement trading army. They are humiliated. But they (or others like them) will be back. The odds don’t change for the casino that loses a fortune to one lucky player. The house simply takes the loss and moves on.
Will that mean big changes in hedge fund strategies or regulations against shorting? Not likely. The hedgies will pull in their horns for a while and lighten their short positions. They’ll be more cautious about shorting stocks that have small floats and the smart ones will keep an eye on the Reddit boards to see when the basement army is gearing up for a mass counter move again. But the industry has long convinced the SEC that shorting has a role in the markets, so the regulators might only apply a few new limits here and there to keep this from becoming a more systemic problem.
On the other hand, regulators will also take a hard look at the innocent perpetrators as well, as it does not like even the smell of collusion wafting through its markets (other than the collusion permitted at institutions). And it has gone after small investors before in order to protect the “integrity” of the markets.
The third group will be the losing investors who bought into the frenzy and there could be a bunch of those. These are the poor followers who jumped in at already ridiculous prices with huge risk — the ones for whom the greater fool theory was named.
Let’s face reality. The stock WILL come back to sea level. It is only a matter of time, speed and ultimate price. A value for GameStop shares in the 300s or even 100s is completely unsustainable for any material period of time. Once the funds have either closed or hedged their positions and the Reddit crowd runs out of new recruits to play the role of the greater fools, the stock will plummet like a dead weight.
GameStop is not bitcoin, where people can build lofty narratives around a $100,000 price. Who, except for the short players and greater fools, will buy the stock at absurdly high prices? If anything, you will now have stock owners, mutual funds, and the company’s own executives clamoring to take an unseemly profit while they can.
The basement army may think they can just hold on, but that’s a lot easier for the earlier entries to do. If you purchased stock at $200–400 per share and it drops a hundred points, your behavioral protection system will kick in and the sell button will get hit. Trust me — loss aversion is real science.
Does any of this bring Tulip Mania, Bernie Madoff, or bitcoin to mind?
It should. They are/were unsustainable speculative bubbles as well. And in the case of bitcoin and Madoff, there was a very similar battle cry from the investors who exhibited glee not just at making money, but at having one-upped the financial establishment as well.
Just as with GameStop, there were (or will be) three groups in those instances with the same fates — those that got in early, got lucky, and got out, those who stepped in front of the mania and got crushed, and those who were late to the game and bought in way too high.
So, a clever, albeit bold strategy went viral and got powerful enough to catch a handful of hedge funds at their game. Two points for David against Goliath and kudos to a non-professional for having the insight to know what would happen when you rally a bunch of people to start buying a heavily shorted stock. But does that mean the Davids of the world now have the upper hand? For a while perhaps, but remember, only the early Davids won in GameStop. The late-to-arrive Davids are going to get taken to the cleaners. If you win a battle but a big percentage of your warriors die in the process, where does that leave you for the next battle?
