GameStop: The new wolves of Wall Street, their bets and the old big bears’ squeeze

The frenzy around GameStop (GME) – the new-found darling stock of intraday traders that has caught the world of investing, financial markets and industry watchers by surprise is a saga that has many lessons and implications. First, a quick background. The brick & mortar retailer of video games has been facing headwinds on several fronts – hardware cyclical downswing, shrinking store sales, declining growth of malls (where most of its stores are located) and rapid uptake in digital gaming/consoles. These factors together with pandemic-induced recession sparked off a wave of short-selling in its stock by a horde of hedge funds who bet heavily on its price to crash. But the Wall Street’s biggies were taken off guard by a bunch of amateur investors who banded together on an online message board to drive GameStop’s price up through the roof, thereby sending the hedge funds into billions of losses – all within a short span of few days. And they succeeded!

The meteoric rise of GameStop from $19 to $482 in a span of a month is jaw-dropping and perhaps will go down in history as a market blockbuster produced by main street retail investors to avenge the manipulation and hegemony of Wall Street biggies. But beyond that, the epic rally and the subsequent rout has far more learnings, takeaways and implications.

Photo by Clay Banks on Unsplash

One, and by far the biggest is the power of social media to unsettle established institutions. How just an in-joke that went viral on Reddit subgroup caused the flash rally in a stock that had massive short positions by some of well-known hedge funds, illustrates the network effect of social media. By enabling real-time dissemination of info across a broad base of users located continents apart, social media has blurred geographical boundaries while making it possible to nationalize or even globalize local protests & issues as seen in the past with #BLM, Arab Spring, Boston Tea Party and Occupy Wall Street to name a few.

Two, the confluence of social media, big data and tech platforms to effectively mobilize funds/resources by bringing together thousands of people with little or no preparation to vocalize activism. The intent could be to execute offline activities or shape on-the-ground tactics (such as anti-government protests, coup or ousting of state heads) or to collude for a financial gain, as is the case with GameStop. The advent of AI-based tools which can monitor social chatter around stocks in real-time or track buy/sell recommendations by bloggers and influencers and gauge retail investor sentiment will only make it easier for orchestrating targeted disruption of companies. This will also likely expedite democratization of finance with the rise of fee-free trading tools, DeFi apps and DLT platforms providing further ammunition.

Three, understated capabilities of little fellas to organize a coup on the elites. Access to internet, smartphone & information-sharing platforms such as Reddit or Twitter has empowered the revolutionaries, giving teeth to vigilante populism. Boycotts, revolts and uprisings today largely have digital roots but can be physically devastating like the Capitol Riot last month or the Hong Kong protests in 2019. All these bear one thing in common – most often than not, they are initiated and led by ordinary people to express dissent, anger and frustration with the system - reflective of Mass vs Elites battle. GameStop is no different and could be ‘Occupy Wall Street’ in real sense.

Four, the Reddit-fuelled rally has brought to fore loopholes in market structures and regulation. By ascribing a moribund stock nearly a same price-to-sales multiple as that of Amazon and by valuing it over 22X its intrinsic worth, the episode has not just mocked valuations, but also turned investing into betting - only to display anti-establishment sentiment. The absence of intra-day circuits, prevalence of active SLB market and less restrictive margin limits among others could attract regulatory scrutiny.

Five, it has shown that shorting at the start of an economic cycle would mean more pain trades, more so when betting on a penny stock. The rebel investors cleverly timed the build-up and execution – at a time when equity markets had a sharp rebound following the 2020 pandemic selloff and were rallying on continued optimism over vaccine rollouts. Contrarian calls, especially the buys are not always bad, but shorts in an up-market following a Black Swan could lead to a squeeze. GameStop is one classic case.

Six, the role of celebrities and influencers in not just pumping up stocks but also fuelling popular movements further underscores their clout and power. Elon Musk, the world’s richest man’s tweet ‘Gamestonk’ with a link to Reddit trading group was just the shot in the arm that propelled GameStop to the moon. Similar instances of him endorsing the secure messaging app Signal a few weeks ago and the most recent one of him rallying behind the crypto coin Dogecoin, show celebrity influence on brands and markets. In GameStop’s case, Musk’s tweets have helped both the enabler (Reddit) and the executor (Wall Street Bets) – the former seeing a 2X jump in valuation while the latter making a windfall gain on stock’s surge.

With a 33X rise in stock price in less than five months, the mom-n-pop investors may well hail it as a victory over Wall Street powerhouses but with a business model that is upended by forces of digital transformation and fundamentals under constant erosion, it isn’t hard to foresee the fuzz fizzling out sooner than later. And as it is, the stock is already 82% off its peak which has erased over $25B in market value. At best, such strategies prove to be momentary trades offering instant gratification of having done the screwjob and beating the pros at their own game. To replicate such manoeuvres at a broader market level or in large-cap stocks may look far-fetched. Moreover, individual capacity of retail traders is limited but that said if such cornering of large institutions results in disorderly unwinding of positions even by one of them, it could open up a contagion and pose a systemic risk.

The GameStop showdown has brought the little wolves of main street to limelight, adding a bounty in fortune to their kitty much to the chagrin of the big bears. That their actions and the build-up transpired on an online community of 4M+ users shouldn’t really some as a shocker given similar exploits observed in the past to expose fault lines in political systems, social practices and corporate structures. This therefore makes GameStop a grey rhino, arguably may be better than the black swan of 2020 but leaves much to reflect upon the power struggles, hierarchies, asymmetricity and polarized world. For now, the game isn’t over yet.