I’ve been kicking around a lot of thoughts about GameStop(GameStonk-thanks Elon and Reddit) lately. Who hasn’t? This time, there’s no exception to the fact that my thoughts tend to run contrary to popular sentiment. Normally, when droves of people get excited about something, I tend to get worried. Since I value contrarianism as an exercise in courage, I have to share my thoughts in the interest of consistency. I’ll be using GameStop and GameStonk interchangeably, since the former is the name, obviously, and the latter is fun.
First Thing’s First: Defining GameStonk Related Terms
By now you’ve heard of terms such as short selling and short squeeze. There’s been plenty written about what these terms means, but in the event you aren’t familiar, it’ll be helpful for me to define them so everything else makes sense.
Shorting a stock simply means to bet against it. Traditionally, people hold long positions in equities. They buy the stock expecting the value to rise. A short is the opposite. They sell shares expecting the value to drop and profit accordingly. There are many ways this is accomplished. What hedge funds have done with GameStop stock is borrow the stock and sell it. They expected to buy it back later, after the share price dropped, return the shares to their owners, and pocket the difference.
What’s driven the share price up is the short squeeze. I’ve written previously about short interest, the percentage of all outstanding shares being borrowed and sold in this post for the top 50 companies in the world by market cap. At the time at least, Danaher had the highest short interest at just under 10%. GameStonk, by comparison, was at ~140% at its highest.
How is this possible? Simple; someone borrows a share, sells it, then someone else borrows it from whoever they sell to. One share can theoretically be borrowed an infinite amount of times.
The GameStop Short Squeeze
A short squeeze occurs when, picking up on outrageously high levels of short interest in a company, investors rapidly accumulate long positions (buy shares) of that company. The resulting demand raises the price of the stock. As a result, the shorts position rack up losses. Short sellers are essentially extended loans in the form of the shares they borrow, and while their positions are still open, meaning they haven’t bought back and returned the shares they owe, they need to pay interest on these loans. It not only becomes costly over time to keep short positions open for this reason, but also as losses mount, the short sellers need to put up additional collateral to prove to their creditors they can repay what is owed when they want it.
As a side not, anyone who loans shares to short sellers can demand their shares back when they please, though normally they don’t do so provided the interest payments are made.
So, when short sellers see the price move upwards, they get spooked and scrambled to close their positions. Since so many shares are being bought by the long holders, it creates a lack of supply relative to the demand, which only drives the price up even more. The short sellers become increasingly desperate, and the losses mount as the price continues to rise.
What Are GameStonk Long Holders Trying to Do?
The overarching narrative since this has begun is that this is a concerted effort by regular people, if you will, to stick it to the Wall Street titans who have been screwing over, well, everyone else in their pursuit of obscene profit they have no real use for. Most of these guys had more than enough money to buy all the toys they could play with a long time ago. That hasn’t stopped them from continuing to manipulate markets, exacerbate risk using extensive leverage, and spread it around the financial system with exotic and esoteric securities. A lot of people are angry with them, and by them I don’t just mean hedge funds. I’m talking about all institutional investors.
Frankly, I agree with these sentiments. Fuck them. Again, them meaning the institutional investors. They are in large part responsible for much of the economic catastrophes we’ve suffered through. And when I say we, I don’t mean that to include them, because, like true parasites, they always make out like bandits. Rarely any comeuppance or accountability.
The GameStop buyers, the guys from Reddit are really trying to stick it to the institutional investors that are in their crosshairs. They intended to keep their losses mounting, doing as much damage as possible to the culprits behind the world’s many economic woes. By driving the share price higher and higher, they hope to compound the hedge funds losses and misery, and make them pay for their malfeasance.
Clearing Up A Few Misconceptions About Short Sellers and Brokerages
Like anything with a wide variety of inputs, there are going to be glaring misunderstandings about what’s going on. A lot of the resentment aimed at the Wall Street overlords overlaps with a general resentment towards short sellers. This resentment is predicated on the notion that short selling causes stocks to fall, hurting companies, 401Ks, small investors etc. While institutional investors certainly manipulate markets to their advantage, and the deck is heavily stacked in their favor, short selling in and of itself does not manipulate markets. Not anymore so than taking a long position does. Short selling serves an important purpose; maintaining market equilibrium.
Bubbles, as we know, are really not good. Some people laugh all the way to the bank on the way up. But, they’re mostly those who are already well to do. The little guys are usually bag holders when the dust settles. While bubbles still exist and likely always will, short selling serves as a counterbalance to irrational exuberance, which feeds into bubbles. By counteracting this exuberance, shorts can help make bubbles less commonplace.
Unless regulators find more information about brokerages, particularly Robinhood’s, decisions to limit buying of GameStop, it would seem there wasn’t anything fishy going on. It reeks of impropriety because they earn money on what’s called Pay for Order Flow for Citadel Securities, who was invested in Melvin Capital, a hedge fund with a heavy short position in GameStonk. Pay for Order Flow means Citadel pays Robinhood to execute trades RH’s customers make through the app. People jumped to the conclusion they were protecting Citadel from the mounting GameStop short losses, and by extension, helping them wage class warfare.
It Gets Worse…
I made the mistake of getting into something of a row with this class A idiot on LinkedIn, all by making the apparently hubristic mistake of asking for evidence of his contention in the screenshot. After steadfastly refusing, he posted an SEC disclosure on a different thread, which had records of Citadel’s PFOF to RH. What the meme trading Einstein didn’t realize is that makes Citadel a customer of RH, not an investor. It’s the difference between the McDonald’s franchise owner and the people standing in line. Goes to show how easy it is to get tripped up about everything going on.
“Caesar’s wife must be above suspicion”, Julius Caesar once said. I won’t go in to the exact anecdote this quote comes from, but it means the mere appearance of impropriety is bad enough, which RH is learning the hard way. But they, like WeBull, Public, and many other brokerages have explained they had to stop processing orders because the clearinghouses that settled these trades demanded more collateral from the brokerages. Brokerages are required to put up collateral in order to guarantee the faithful execution of trades. It helps support the necessary fidelity markets require to operate effectively.
With so much activity going on around GameStop, the clearing firms companies like WeBull use, Apex Securities, or RH’s clearing firm which it owns and operates, didn’t have the necessary collateral the clearing houses demanded. That’s why RH drew on credit lines after first stopping trading. That money was used as collateral for when trading on GameStonk began again.
If it had been only Robinhood that halted trading, I would certainly understand the suspicion. But they weren’t alone in doing that. They just stood out by having Citadel as a customer.
Is Shorting GameStonk Working?
The obvious place to look for the answer to this question is at the most notable GameStop short sellers. Some of the results are promising. Citron, which has been publishing research about which stocks to short for 20 years has decided to end that practice. I don’t agree with trying to end short selling, but for those who do on WSB and in the greater world, they’ve scored a success here.
As for successes with hurting the hedge funds, that’s a bit more limited. Melvin Capital, founded and run by Gabriel Plotkin, a Steve A Cohen protege, has mistakenly been described as having been “taken down.” Melvin capital did lose 53% of its investments, but never declared bankruptcy. Nor will it as a result of the GameStop kerfuffle. Citadel and Point72, Cohen’s fund, bailed it out with $2.75B. The squeeze also won’t affect it anymore. Plotkin confirmed on CNBC that Melvin’s short positions had been closed by January 26th, and that rumors of it going bankrupt were false. And apparently, it’s lining up more investors.
Point72 has apparently lost 15% and D1 Capital Markets, a hedge fund invested in Robinhood, has lost 20%. As of the time I’ve started writing this, the overall short interest in GameStonk has plunged to 39%, so not nearly as much potential to do damage anymore, especially as the short positions continue to get pared back.
How Much of A Role Did Retail Investors Play in GameStop’s Rise?
There’s no doubt that WallStreetBets over on Reddit got the ball rolling on this. However, it’s unlikely WSB and retail investors in general are responsible for the entire run up. Just like people have been saying retail investors in RH have been inflating today’s epic bull market, it probably isn’t true. ~80% of all equities in the U.S. are owned by institutions. It stands to reason far less than the full ~20% of retail investors got involved in this. That likely being the case, it’s hard to imagine retail investors were a true force to be reckoned with.
On the other hand, there may be some sad irony in this whole sordid saga. Famous billionaire Chamath Palihapitiya billionaire bought calls early on for $115 and donated the profits to David Portnoy’s fund to help small businesses during the pandemic. Following suit was Justin Sun, another billionaire, telegraphing his move into a long position on GameStop.
These anecdotes on their own are not enough to prove big money and institutions were pumping up GameStop’s stock, but they indicate it was more than retail investors. 1.7M of the outstanding 69.7M shares are owned by Michael Burry. Doesn’t seem like a lot, but it is for one person. The largest individual shareholder, MUST Asset Management owned 4.7M shares. I use the past tense because that was before they locked in ~$3B in gains by selling on January 27th. We may never know just how much retail investors had on driving this up, but I see the indicators saying the effect wasn’t as profound as its most adamant cheerleaders believe.
Hedge Fund Update
I wrote the above before discovering what I’m including below, but I’d like to leave it there since there’s some interesting information. Learned through my TDA account that some hedge funds profited massively by timing this bubble. Include a screenshot of the article below. Has a few hedge funds going on record talking about the gains they made.
Can’t link to it since it’s behind a credential wall. May be hard to read, so I’ll point out the highlights. Hedge fund Senvest Management LLC profited $700M from long positions in GME.
Another hedge fund, Mundrick Capital Management, made $200M off of AMC, which is relevant since what’s happening with that stock is a similar phenomenon.
As you can see from this thread, plenty of the “little guy” retail investors left holding the bag. So, some hedge funds got burned and lived to see another day. And others laughed all the way to the bank. The cost was several bandwagon enthusiasts losing money that could, at the very least, be put to better use. All I see is failure in their mission to balance the scales. The dragon they were trying to slay turned out to be a windmill. What sets this apart from all of the times hedge funds screwed over regular people is that the regular people did this to themselves.
What’s it All Coming to for Short Sellers and Hedge Funds?
Thinking about this bothers me. Despite all the screaming about a new dawn, a revolution that will upend the world of finance and user in egalitarianism in financial markets, everything that’s happening here has happened before. Usually, this sort of thing ends badly.
The vitriol towards the hedge funds, as I said earlier, is understandable. They deserve it. But the reason why they’ve earned such wrath is because of the impacts of their behavior. That is, it’s all bad for people with significantly less power than them. The kinds of people they step over as they climb the ladder of obscene wealth even higher.
But this whole thing is just a revenge ploy, and while that’s tempting to anyone with a sense of justice, it tends to make those seeking it into the same sort of monsters they seek to destroy. It’s like the freedom fighter who becomes a tyrant after a successful revolution. It’ll be business as usual for Melvin, Citadel, and Point72. They may not be so bold in their short positions, but they’ll continue making gobs of money. The people who will ultimately suffer, like with all asset bubbles, is the little guy. The people the supporters of this bloodlust induced mania are supposed to be sticking up for.
How are the GameStop Enthusiasts Responsible for This?
Many have said they will hold GameStop even if it becomes completely worthless, without heed for the cost. That’s fine if you can afford it, but this sort of thing spills over. There will be many bag holding people who cannot afford to lose when this comes crashing down to earth. And crash it has. The short sellers have cut their losses, so there’s nothing left to squeeze, and GameStop sure as hell can’t justify it’s rally led valuation. The big long positions on GameStop are going to close, like with MUST, as those institutions seek to lock in their gains. This will all dampen the rally by increasing supply and lessening demand for the stock.
And if this had all actually worked, and the short sellers went belly up, then where would the demand for GameStop shares come from? Whichever way you look at it, GameStonk’s market cap has to come back down to reality. When it does, everyone holding out for another rally is going to suffer losses. As will all of those who got in late on the way up. No matter how you slice it, the smaller investors will get burned for playing with fire. And if everyone cheering on this rally is heedless of that fact, they can’t claim any moral high ground. They’re guilty of much of the same malignance as the hedge funds they despise.
Who Else Has Profited Similarly to GameStonk?
An additional anecdote demonstrating how the wave of short squeezes is rewarding people who don’t deserve it is Koss. They’re currently plummeting back down to earth, but not before the Koss family hurriedly sold off shares, which may have kicked off the current readjustment. Koss has razor thin margins on revenue that’s been plunging for years. The shorts were justified as they were with GameStonk. In other words, incompetent business people running a shit company enriched themselves at the expense of regular people they left holding the bag.
What Does the Future Hold for GameStonk, Robinhood, and Short Sellers?
As for GameStonk, I’ve covered that mostly. Other than the market cap coming back down to a reasonable level, GameStop will continue doing what it does, which isn’t good. GameStop has been losing money for years, and it’s not a hyper growth startup. It’s just a bad business, and short selling wasn’t driving the price down. Short sellers just realized it would go down, under normal conditions. Perhaps GameStop will go into bankruptcy eventually. Seems like an inevitable outcome for a company that continues to hemorrhage money. If GameStonk enthusiasts actually care about helping the company, they should buy games and not stock.
I’m not an authority on the law, but it doesn’t appear Robinhood actually manipulated markets. The SEC may take a look and find they did. Also, they may not, in which case many people will howl for blood as they’ve already settled on the notion RH is guilty of something and refuse to be convinced otherwise. As for the lawsuits cooking up against it, doesn’t seem like they’ll go anywhere. Robinhood is not bound by its user agreement or by law to execute any trade. Unless regulators do in fact they were manipulating markets or favoring certain investors, these lawsuits will likely not succeed.
As far as the short sellers are concerned, I’d be surprised if they didn’t learn anything from this. Leeches they may be, but they didn’t get where they are by being stupid. They won’t stay away from short selling, they’re just going to be more surreptitious about how they go about it.
And for Everyone Else?
It’s kind of silly to think this is really going to usher in a new paradigm by tearing Wall Street tycoons down from their pedestals. Melvin Capital lost ~$8B.. The overall value of the U.S. equities market is over $50T. The total losses for short sellers in GameStonk won’t even amount to a rounding error. There was something of a sell off of long positions by hedge funds to cover their losses that the market felt. But that was probably more a result of panic about the general direction of the public. Considering the size of the short sellers losses compared the stock market, it’s hard to fathom plugging that hole is what brought equities down across the board.
Petitions have been floating around Reddit to get short sellers to disclose more about their positions. If that does result in some kind of change, the cynic in me believes the rowdy mob will be happy with its window dressing solution and turn its limited attention span elsewhere.
From what I’ve gathered, regulators believe the market infrastructure held up pretty well. If that’s their sentiment, I wouldn’t see too much reform coming out of this.
Again, the cynic in me rears its ugly head. I feel like there’s nothing the institutional investors can’t work around. If anything, regulators will probably try to prevent future short squeezes out of fear very large ones might actually cause a real problem. We’ve been trading shares of companies since the Dutch East India Company, and though much has changed, much remains the same. Some obscenely wealthy people hoard most of the gains, leaving crumbs behind. I’m not confident GameStop’s legacy will change that.
If GameStonk is a Revolution, it’s the French Revolution
Only King Louis XVI is keeping his head, the Robespierre brothers still lose theirs, and some even more belligerent asshole will likely come along to ruin things for everyone in a few years.
Case in point, u/deepfuckingvalue aka Roaring Kitty may be asked to testify in front of Congress. Congress probably wants to know if this is all some pump and dump scheme he concocted. He shouldn’t have to worry too much, since he lost $19M in two days. If this was a scam, guess he forgot about the dump part. This is what you can expect from obstinately holding onto a stake with an implausible valuation.
As of 2/9/2020, short interest has declined in GameStop to 42.24% according to TDA and 42.27% according to Finviz.
More disturbingly, Yahoo! Finance and The Harris Poll surmised that as many as 28% of all Americans invested in GameStonk or other viral stocks making the rounds in the news. Needless to say, for reasons explained above, this is disconcerting.