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Easily the biggest market story of this week was the mammoth short squeezes in discount-rack stocks such as GameStop (GME), AMC Entertainment (AMC), and BlackBerry (BB).
Take GameStop, a mall-based retailer that had been left for dead by Wall Street. GME was in the 50s in 2008 and in the 30s and 40s as recently as 2015, back when the stock was valued as a multiple of future earnings estimates. GME then fell on hard times, and shares dipped below $3 in March 2020 as the vultures circled.
The vultures of March 2020 were hovering over the Pokemon cards, action figures and pre-owned games on sale in moribund GameStop stores. That kettle of vultures was pushed aside recently by an entirely new kettle of vultures: retail investors of WallStreetBets and Robinhood, who saw vulnerability in hedge funds with big short positions in GME.
Retail clicked buy on GME, and the stock soared from $19 at year-end, to $35 on Jan. 15 and $65 on Jan. 22. The short squeeze was only getting started; GME reached $380 on Jan. 27 and $480 on Jan. 28. AMC ran up a comparatively modest 300% this week, from $5 to $20.
There are parallels between now and the very late 1990s — valuations get unhinged from fundamentals, certain names see jaw-dropping gains, and retail-trading mania rules the day. But at the same time, there is one huge difference: 20+ years ago, retail investors got hosed; this time, they won, the battle at least if not the war, as Melvin Capital and other hedge funds took a bath as Reddit posters smirked.
What does this parable mean for the broader market ecosystem? Well, after the ‘tech wreck’ of 1999-2000, and the global financial crisis of 2008-2009, many retail investors lost interest and/or confidence in the markets. Institutional market professionals spent a lot of time and energy in the 2010s trying to figure out how to bring them back — this was frequently expressed as a priority goal at industry trading conferences in the early/mid 2010s.
Retail order flow represented about 20-25% of stock-market activity in 2020, up from 10% in 2019, according to industry estimates. Aside from the quantity, there’s also the quality, because for investment managers seeking trade counterparties, the best market ecosystem is a diverse one, with different types of market participants buying and selling different stocks, at different times, and in different ways.
So how will this GameStop and AMC mania play out? It had already begun to reverse course on Jan. 28, with GME and AMC both down almost 50%. But not even those slashed-price valuations could be defended by even the most optimistic analyst, based on fundamentals of the businesses. So, GME, AMC and other super-spec names will most likely sink further, and retail investors who arrived late to the party will get hurt.
The last thing retail traders want is another big traumatic rout, and the last thing institutional market participants want is for retail traders to go into hiding for another decade. Let’s hope this latest chapter ends with a manageable, contained unwind of some sort and neither eventuality happens.
