FIVE THINGS YOU SHOULD KNOW
1. Equity Markets – saw a week of volatile trading this week leading to a -3.33% decline in U.S. markets (S&P 500) and -3.70% drop in international stocks (EAFE).
2. Fixed Income Markets – were mixed this week as investment grade bonds (AGG) rose 0.5% while high yield bonds (JNK) fell -0.50%
3. Fed Update – Citing a resurgence of pandemic concerns heading into 2021 and a weakening labor market, Fed Chairman Powell reiterated this week that there would be no reduction in support for the economy for “some time.” Powell was also asked about his views on potential asset bubbles in the stock and housing markets as a result of Fed policy, and responded by stating as of now the Fed does not show any issues with long-term financial stability of the economy.
4. Hedge Fund Titans vs. WallStreetBets – This is a topic we will cover more in depth in our commentary and video, but the dominating headline of the week was the astronomical runup of GameStop (among others) stock as a result of Hedge Fund Short Sellers being forced to cover their shorts as retail investors piled into the stock, thus amplifying the runup. The fallout is far from over, from impending congressional hearings and class action lawsuits, and will lead to a great case study on market dynamics and the strategy of short-selling as a whole.
5. Key Insight – [VIDEO & ARTICLE] We breakdown the details around the headline grabbing story involving Gamestop and the battle between a group of Reddit users and multi-billion dollar hedge funds; as well as the discuss some key takeaways for serious investors.
INSIGHTS for INVESTORS
I got my start in the investment business 26 years ago, right at the outset of the dot.com era. With all due respect to the housing bubble, I haven’t this type of mania, half-baked narratives and self-aggrandizing type trading behavior since the 90’s. Everybody’s buddy is suddenly a genius trader with a special fool-proof process, once again the best performing stocks have no earnings, and there are lots of explanations for why “this time it’s different.”
Please don’t confuse the above sentiments of joining the chorus of doomsayers who are painting all markets and assets as being in some catastrophic bubble that you can only be protected from with gold or bitcoin – preferably purchased through them of course.
This is simply yet another time to check one’s emotions, double check the process and do your best to avoid the hysteria that seems to be on the uptick.
What’s the Deal with Gamestop?
I’m sure this week’s saga will at some point become a 2-hour Netflix documentary, but let me give the quick recap of what went down this week – at least as best as anyone knows at this point.
The short recap is a group of “traders” that were a part of a message board on Reddit called WallStreetBets (WSB) decided, depending on the person you ask, that it would be funny, profitable and/or a proper serving of justice to hedge funds to collectively bid up shares of Gamestop (a national video game retail chain).
Depending on who you ask, before this saga began Gamestop was a company with new management and a great turnaround story that made for a great investment (see the WSB crowd and some professional analysts) or a company that continued to bleed money (they lost $471 million in 2020) and would soon be irrelevant as more and more of its market went digital and thus should be “shorted” (e.g. betting its stock price will drop by using a third party to sell someone else’s shares today and profiting by “replacing” them at a lower price) which the hedge fund community had done in a large way.
Some see short-selling, particularly by the hedge fund community as predatorial, as they would short a stock and then publicly trash it to drive the stock down and often the company out of business. While others, see short-selling as a necessary part of markets for reasons ranging from providing liquidity to advance warning of troubled companies as was noted by Jason Furman, a professor of practice of economic policy at Harvard and former chairman of President Barack Obama's Council of Economic Advisers who is on record stating "Short sellers have alerted us to problems in companies before the government and others did, like at Enron.”
Compounding the emotions around this “battle” was the fact that the general demographic of the WSB thread tend to be men in the 30’s that have a sentimental attachment to Gamestop and hated to see it “attacked” by hedge funds. The thought was that they could protect their beloved store and also “stick it the man” by ganging up against the hedge fund community’s short positions in Gamestop … and it worked. By Wednesday it was official that they had not only bankrupted the hedge fund Melvin Capital, but cost other hedge funds billions as well. Furthermore, when hedge fund Citadelattempted to come to Melvin’s rescue the WSB group went after other stocks shorted by the Citadel.
As of Thursday, the saga seems to have come to an end for now, but not without controversy, after virtually all major trading platforms banned purchases and options trading around the stocks in question. “Wall Street” defended the actions as necessary because the trading volume and volatility was too great for the reserve positions they had in the stocks, while “Mainstreet/WSB” claimed it was further proof of Wall Street rigging the game to protect themselves.
Compounding the controversy is that not only is Wall Street “banning” buys, but now social media networks have begun to shut down the servers connected to WallStreetBets due to “hate speech” and other “impermissible behavior.”
What Can We take away from this story?
No Sure Thing – The first key takeaway, which is something we all need a constant reminder of, is that a process built around being the “smartest” or having a “fool-proof process” almost inevitably ends with one looking stupid and foolish. One week ago, Melvin Capital was a well-respected hedge fund with $13 billion in assets and this week it is gone because of a combination of greed and an “unknown/unforeseeable” event.
They aren’t alone, history is replete with examples from countless individual that chased tech stocks in 1999 to the greed of Wall Street that took down the likes of Lehman Brothers. We all want to believe in magic and/or our own intelligence but its humility and discipline that can stand the test of time.
Too many investors confuse good markets with a good process and end up getting burned in the end – I know it’s a lesson I learned early on. Today’s market is replete with examples of people chasing high-flying story stocks that seemed destined to eventually crash, consider the following from Schwab Chief Investment Strategist Liz Sonders.
Don’t Underestimate the Power of the Mob and Wanting to Belong
A number of years ago I read a fascinating book entitled Among the Thugs by Bill Buford. It was an incredibly interesting read regarding the culture, particularly in the 90’s, around European football teams and the “firms” (i.e. gangs) that supported them – but also a very informative one regarding mob mentality and the power of people’s need to belong.
I am not here to judge the actions of the WallStreetBets crowd, but it is another interesting example of people turning investing into something much more personal. Whether their desire to belong to this group, crusade against Wall Street or simply get rich quick it is pretty clear that the actions of many didn’t fall into the category of true analysis and appropriate application to one’s goals and circumstances (e.g. a lot of people are going to lose their rent money on this stock).
Perhaps this group seems silly to you, and you say you’d never be part of such a thing – but ask yourself if you’ve ever wanted to deviate from your plan, to abandon your risk tolerance to chase a hot stock or stock market or perhaps felt a twinge of jealousy at a friend bragging about a successful stock trade. The impact of fear and greed and the corresponding pull of going with the herd is something that impacts us all without proper safeguards.
What are your safeguards?
The Game is Only Rigged If You React
Stop me before if you’ve heard the story of two sides acting in both petty fashion and one designed to hurt the other side while simultaneously claiming the moral high ground. At the end of the day, it is bogus that hedge funds can (in some, not all cases) conspire to take down stocks/companies solely for their profit, but so too a group of traders targeting a company out of similar spite is not much better. Many investors look at the wild swings of both the stock, and to some degree stock market, due to these events and lament that the game is rigged, and their hard-earned money is vulnerable to the attacks of shadowy forces.
The truth, whether it’s about the wild ride of a single stock like Gamestop, the euphoria of a bull market bubble or panic of a bear market sell-off is you can only be victimized if you abandon a prudent plan and join the fray by chasing or selling. There are always players from the brokerage houses to the media trying to play you for their gain, but that doesn’t mean you need to be played let their actions cause you concern.
Stay the course, and have a great weekend!
Tim and the team at TEN Capital