The financial media took a brief break from attempting to predict everything that will happen in 2021 to bring us the engaging story of how masses of investors managed to bid the share prices of three largely-unprofitable companies—GameStop, AMC Entertainment Holdings and Blackberry—up nearly 1,000 percent, collectively. 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.)
The story was allegedly about David (the small investors) pitted against Goliath (several prominent multi-billion-dollar hedge funds), and the only reason you heard about it is because the small investors won and nearly put the hedge funds out of business.
Market professionals recognize the story as a classic short squeeze: investors on one side (in this case the hedge funds) borrow the stock of companies they think are overpriced, expecting to buy them at a discount after the fall, allowing them to pocket a quick profit. Eventually the short-sellers need to cover their shorts, so if the stocks unexpectedly rise in price, some of the short-sellers have to scramble buy the stock at the inflated price to limit their losses. On the other side of the gaming table were a group of investors who engage in online conversations who ganged up to raise each other’s bids. When the hedge funds were forced to buy to close out their positions, the share prices went through the roof. 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%.
It is worth noting that this sort of activity is not investing; it is, instead, a form of gambling, and the story tells us a great deal about the mindset of many who participate in the market these days. When their goal is to make bets, and destroy other gamblers at the table, the game for everybody else becomes increasingly dangerous.
At some point there is an invisible line that is crossed, when the speculator 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.
One can make the reasonable assumption that, 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. The jubilant traders can enjoy their winnings today, but it may not be long before they are counting their losses and wishing they had not gambled away the money that could be used to buy shares when they finally go on sale.
This article was written by an independent writer for Brewster Financial Planning LLC and is not intended as individualized legal or investment advice.