Jonathan Marriott, Chief Investment Officer
In the twentieth century, US broker Merrill Lynch became known as the 'thundering herd'. Their vast network of investment advisors and clients meant that their recommendations actually moved markets. Their logo of a raging bull pretty much reflected their position in the market. This week, we have seen evidence that social media is taking a head-on tilt at Wall Street. At the centre of a frenzy of activity has been GameStop, a very twentieth century bricks-and-mortar computer game shop. Its share price, which had been as low as $2.47 in April last year and started this year at $18, rose this week to as high as $483 at one point on Thursday. It then collapsed to $110, but on Friday morning was $365 in the pre-market. Last year, it traded around 5 million shares a day, but on Tuesday the volume rose to 178 million shares - more than twice the total shares in issuance traded in a single day! Huge swings in price with unprecedented volumes, but little real news. So what is going on?
How it started
GameStop is not a name that many investors here will have heard before this week. For good reason, as selling computer games through shops rather than online was not a great business, even before the pandemic and associated lockdowns closed many of them. The share price unsurprisingly fell as the pandemic closed down bricks-and-mortar shops. Hedge funds sold the stock short on the expectation of a further decline in the share price, or the company going out of business alongside the many other retailers who have suffered in the last year. Short selling is selling stock you don’t own in the expectation of buying it back at a lower price. Selling short is inherently risky, as if the share price is $10 the most you can make is $10 assuming the price goes to zero but, if the price rises, the loss is potentially unlimited. Hedge funds may sell short one stock and go long another in the expectation of a relative shift in price. So selling GameStop with shops on high streets and buying an online retailer such as Amazon may have seemed an obvious bet during the pandemic.
Chat versus hedge funds
However, given that this trade seemed so obvious, the amount of GameStop shares that had been shorted was more than the total number of shares in issuance. Chat rooms with people who liked the shop started to talk the stock up. Online brokers such as Robinhood saw a rise in buyers (particularly in the options market, where you only need to put up a fraction of the capital to buy) and the price began to rise.
When buying the option, the person writing it can cover their position by buying actual shares. This adds gearing to the market and can accelerate moves to the upside when they happen, as those who have sold the options buy even more stock to cover their positions. For technical reasons this accelerates as the price rises. Online Reddit's WallStreetBets participants shared the idea of buying the stock and squeezing the hedge funds, gaining more and more attention as the price moved up.
Many young people use the Robinhood brokerage as a cheap way to play the market and much of the volume went through it. Yesterday it controversially stopped people buying GameStop and increased their margin requirements. This precipitated the sharp correction from the highs. Robinhood deny responding to hedge fund pressure (to whom they sell details of their trades. Yes, really) and instead blamed financial requirements for clearing house deposits. Robinhood raised an additional $1 billion from existing investors and banks. Speculators looked for other stocks that hedge funds were short to see if they could do it again – AMC Entertainment, which owns cinemas, saw its share price soar from $5 to $20. Other stocks known to be heavily shorted rose as short positions were cut by nervous hedge funds. On the other side of these trades were long positions that may also have been cut, adding volatility to markets. Indexes have swung around, but dispersion within the indexes has been huge.
Research versus chat
There was certainly a technical situation that could be exploited, but this does not reflect the fundamental value of a company. Is GameStop 'worth' so much more now than it was? Probably not. There will no doubt be investigations into how this could happen and regulations may change after the fact. Sharing opinions and ideas online is not illegal but this demonstrates the power of social media to move markets. Some opinions may be based on careful research, whilst others are based on a whim. Some will be based on knowing the company, but not the valuation. A perfectly good and profitable company may just be overpriced.
The LGT Vestra equity lists consist mostly of large capitalisation companies and are carefully researched. We look at the value of future cash flows and profitability. We assess the ability of others to take a company's market share. We look carefully at trends such as demographics and changes in the way we live. We will assess the risk of something going wrong with our central view. All this, and more, is taken into account in assessing the worth relative to market price, before we approve an investment for use in a portfolio. GameStop was described on television as "worth" $480 at one point. I would suggest that the share price may have been $480, but this is not what it was "worth". That requires a much more complicated calculation.
What is something "worth"?
On a morning when we hear that a portrait by Botticelli has sold for $92 million (after commission), there is a philosophical question as to what anything is worth. $92 million would, after all, pay for 30 million doses of the AstraZeneca vaccine. We all make value judgements every day. When looking at investments, we look at valuations of cash flows compared to the risk to those cash flows over the investment horizon. We will look at expected returns relative to inflation and interest rates. We will also look at ways to balance the risks at portfolio level. We try and ignore the noise from market speculation and short-term swings, however deafening they can become. In the end, chatter from social media will never replace proper analysis, but we cannot totally ignore the impact it has on the price of assets relative to the real worth of a business.
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