How to keep your cool in GameStop market
Even during a calm stretch on Wall Street, the stock market contains pockets of madness. But these days have been anything but calm. One word captures it: GameStop.
It’s no longer just the name of a chain of video game stores at shopping malls. GameStop has become a stock market phenomenon — an eruption of irrational exuberance that, if only for a day or two, commanded center stage in the midst of a deadly pandemic, an economic downturn and a simmering political crisis.
GameStop shares rocketed so rapidly that the rise — more than 1,700 percent for the month through Wednesday — looks like a series of typos: $19.95 on Jan. 12, $76.79 on Jan. 25, $147.98 on Jan. 26 and $347.51 on Jan. 27. Then the price started falling, as retail platforms such as Charles Schwab, TD Ameritrade, Robinhood and Interactive Brokers curbed trading in the stock. But after trading resumed Friday, GameStop moved back up to $325. Where it will it be in the coming week is anybody’s guess.
The stock’s gains had nothing to do with its merits. The company is losing money, as you might expect when you look at its business model: Why, in a pandemic, would you drive to a mall to buy video games when you can download them at home on high-speed WiFi?
While there is a David versus Goliath element to the GameStop stock saga, it is likely to be a cautionary tale. The extreme volatility is reminiscent of the tulip mania in 17th-century Holland, another episode in which rollicking asset prices soared way beyond their intrinsic value. Tempting as it may be to join in the fun, at moments such as these, most long-term investors are usually better off if they stay sober and avoid the urge to make quick profits. A better option would be salting away money in dull, well-diversified stock and bond portfolios.
“Trading in stocks like GameStop is the last thing people should be doing,” said Richard Bernstein, a former chief investment strategist for Merrill Lynch who runs his own investment firm in Manhattan. He said some of the money being poured into the global economy by central banks and governments during the pandemic was “inflating the values of financial assets, and regulators need to be concerned.”
But the wild trading should not distract investors from the big picture, which he said is that despite the pandemic, the world is “shifting into a new, accelerating stage in the corporate profits cycle,” with opportunities in the stocks of sober, moneymaking companies in sectors such as energy, materials and manufacturing. Buying shares of companies with weak or no earnings such as GameStop, Bernstein said, is not the way to go.
Consider that, until it began making headlines, GameStop was notable as an investment chiefly for attracting negative bets — known as short interest — from big institutional traders such as hedge funds, which saw little value in the stock.
What seems to have happened is that a group of individual traders, gathered on the WallStreetBets message board of social media site Reddit, decided to make enough highly leveraged bets to thwart the short sellers and drive GameStop’s price into the stratosphere. The hedge funds had to buy shares of the stock to cover their negative bets — creating what is known as a “short squeeze,” and adding to the upward momentum.
While speculative trading is fun when it’s profitable, it is dangerous — closer to gambling than to serious investing, most academics who have studied the subject say.
“For many people, this can only end badly,” professor Ciamac Moallemi of Columbia Business School said.
Given the magnitude of global financial markets, the wild rise and fall in prices of stocks such as GameStop so far has been limited in scope, and there are few signs of broader disruption.
What could derail the stock market? Many things, of course, including the possibility of opaque, systemic connections between hedge funds that have lost money in the short squeeze and sensitive global financial institutions. The collapse of one moneylosing hedge fund — Long Term Capital Management in Greenwich, Conn., — sent unexpected tremors through global markets in 1998. But that is exactly the kind of thing that regulators will be looking for now.
There has been a flood of initial public offerings, particularly of entities known as SPACs, short for special purpose acquisition companie. Many such companies have traded without earnings or revenues, another indication that a deluge of easy money has led to speculative pockets in the stock market, which could lead to serious trouble.
In the meantime, the long overall rally continues. It began in March when the Federal Reserve and other central banks began a rescue operation, vastly increasing the global money supply and pledging to do whatever it took to maintain financial stability in the face of the economic downturn driven by the pandemic. Fiscal stimulus has made up for some of the income of millions of unemployed people and thousands of failing businesses. In the U.S., if the Biden administration has its way, more aid is on the way.
Thanks in no small part to the infusion of money, asset prices across the board have risen, and interest rates remain extraordinarily low. Big Tech stocks have fueled the rally, helping to make stocks expensive by historical measures. But if corporate earnings rise as expected, the stock market may seem less outrageously priced.
Low interest rates make stocks attractive when compared with alternatives such as bonds, many strategists say, but that could change. Katie Nixon, chief investment officer of Northern Trust Wealth Management in Chicago, said she expected the bull market to live on but that if the yield on the benchmark 10-year Treasury note, now a little above 1 percent, reached 1.5 percent or even 1.75 percent, there could be a severe stock market reaction.
Such a rise is unlikely but possible because government statistics are likely to show an apparent spike in inflation in coming months — in large part because the severe economic downturn of 2020 held prices down.
“There is a super-high probability of very high numbers,” Nixon said, but they are likely to be illusory, reflecting the economic recovery, not a fundamental increase in prices. “Our base case is that both the Fed and the market will understand that and see through those numbers.”