By now, I’m sure you’ve heard or read about the whole GameStop stock market story in the news or online this past week. I realize a lot of ink has already been spilled on this topic and I am not sure I can add much value or color to the discussion. Nonetheless, perhaps my added value can be to try and explain, in the simplest terms that I can muster, this craziness in the stock and derivatives market.
Let me say that the GameStop “short squeeze” debacle has had little effect on the individual investor, because we, and the majority of registered investment advisors I know, do not short-sell stocks in client portfolios. We typically only invest in blue-chip quality and solid value or growth companies, index funds, and actively managed funds. Short selling is more the domain of large hedge funds, who both buy stocks and sell stocks short. We also don’t invest in companies that were already circling the “bankruptcy drain” such as GameStop and AMC Theatres (GameStop stock traded as low as $2.57 last June).
So what is short selling?
Short selling is betting that a stock price will go down instead of up (the exact opposite of what everyday stock investors do). To do this, traders ask their broker/dealer if they have any shares that can be borrowed from someone else’s owned shares in the broker’s inventory. If shares are available to borrow, you proceed to sell those shares (short) in the markets at their prevailing price, in hopes that their price/value goes down. Your objective is to subsequently buy them back at a lower price, and “re-pay” your borrowed shares.
Imagine this being done with millions of shares of GameStop, where so many people were already betting that the stock was going down, but instead, the stock went up these past few weeks, and went up a lot. In fact, as unbelievable as it is, more shares were sold short than the entire number of outstanding shares issued by the company (164% to be exact, so many out there were loaning shares they didn’t even have). If you’re short the shares, and they go up in price, you are said to be getting “squeezed”, and your only option is to buy back the shares at much higher prices before your broker/dealer decides that you can no longer afford to stay short, buys them back on your behalf, and charges your account for the losses (the difference between the price you sold them for and the price you paid to buy them back). Imagine selling your shares short for $65.00 per share on Friday, January 22, only to be forced to buy them back at $313 on Friday, January 29 (GameStop traded as high as $483 last week). That’s a loss of 4.8X your money (or if you were lucky and instead bought the shares, you made 4.8X your money).
What we saw this past week was a concerted effort by members of a Reddit subgroup known as Wall Street Bets (WSB) to force these short shareholders to “cover” their short positions. The whole rush to cover short shares is like tinder for a fire because the higher the shares go, the more the short shareholders have to pay to buy them back in a negative “feedback loop” for their positions. Momentum traders and other investors who see this kind of short squeeze also pile on to try and capture or “scalp” some profits.
While some large hedge fund who do/did hold short shares in client accounts lost a lot of money over the past few weeks, the majority of investment advisors and their clients were largely unaffected, other than the fact that these same hedge funds, in an attempt to ride out the short squeeze, used and sold other blue chip stocks (such as Microsoft, Apple, Johnson and Johnson) to cover their losses on the short sales. That’s why you saw the price of those stocks go down last week.
This kind of thing shall pass, and although this may be the first time you’ve heard about this type of “squeeze”, it has happened a lot in the past and will likely happen again. This type of activity tends to crop up when you have a lot of people receiving government checks who have nowhere to go and have nothing better to do (and therefore nothing to lose), so they might as well risk that money in the markets. The current COVID environment has created the perfect stock market storm. I believe that this is more media hype than substance, and will be out of the news cycle in a short time. Cries for regulating or investigating all of this are misplaced in my opinion.
In other words, it’s business as usual in the stock market, unless you owned or shorted the stocks of AMC Theatres, GameStop, Bed, Bath & Beyond, and a few others. As in other newsworthy stock markets “mania’s”, when the dust settles, the majority of the players will likely lose their money because risk management and profit protection isn’t a regular part of their stock trading discipline. If you’re a long term investor, you should grab some popcorn and enjoy the “show” from a distance, and resist the temptation to jump in and risk your hard earned money. Because when the music stops, I believe that GameStop shares will be back to trading in the low-double, if not single-digits once again.
If you would like to review your current investment portfolio or discuss short-selling, please don’t hesitate to contact us or visit our website at http://www.ydfs.com. We are a fee-only fiduciary financial planning firm that always puts your interests first. If you are not a client yet, an initial consultation is complimentary and there is never any pressure or hidden sales pitch. We start with a specific assessment of your personal situation. There is no rush and no cookie-cutter approach. Each client is different, and so is your financial plan and investment objectives.