What the GameStop craze might imply for the way forward for the inventory market

Tiffany Hagler-Geard | Bloomberg | Getty Images

The stock market is known to be unpredictable and volatile, and any sense of normalcy was blown during the recent GameStop rally.

Most of us know the story by now: after discovering that several hedge funds had bet that the video game retailer would lose value, folks on the Reddit forum WallStreetBets joined forces to raise the share price 1,500%. During January, GameStop’s share price rose from a low of $ 17 to a high of $ 483.

The bubble appears to be bursting already, and GameStop shares have fallen to around $ 55 as of Friday.

Still, the event is unlikely to be forgotten anytime soon, experts say.

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The Reddit forum of retail investors who hold their own against Wall Street still has more than 8.5 million subscribers (or, as they call themselves, “degenerate”). And Netflix is ​​already in talks to make a film that will dramatize the battle royale between giant hedge funds and a group of individual day traders.

Experts also say that the event tells us what people are bringing to market today – and what that could mean for an investment in the future.

More bubbles

In many ways, the GameStop Rally is similar to the bubbles of the past, but it also has some unique properties, according to experts.

“What is new is the size and speed of the event,” said Veljko Fotak, Associate Professor of Finance at the University of Buffalo.

The ubiquity of smartphones that people can download investing apps on, the availability of cheap or free trading, and “a pandemic with a lot of restless energy” are all factors that contributed to the video game retailer’s rally, said Dan Egan, vice president of Finance and Investing at Betterment.

Global populism is another factor that has fueled the bubble, Fotak said. “Some investors were motivated not only by greed, but also by a desire to stick with the man,” he said.

Many people are also put in the market these days when they see friends or people they follow on social media to promote certain stocks, said David Sekera, chief US market strategist at Morningstar. Some of these posts are very compelling: for example, Reddit users shared high-level analytics on GameStop’s finances.

“The days when equity research was limited to the big Wall Street companies are long gone,” said Sekera.

All of these events that drove the GameStop bubble could spur a lot more.

“I think this herding Reddit movement will continue to some extent,” said Jason Reed, professor of finance at Notre Dame University. “We have already started to give significant momentum to the movement in other stocks and assets like AMC, Blackberry and Silver.”

When GameStop’s shares fell on Feb.2, many Reddit users said they would hold onto their shares or even buy more, writing that it wasn’t a loss until they sold out.

Source: Reddit

Experts say that more people invest positively, but only if they do it wisely.

For example, those who buy stocks based on social media posts are often taking risks with money they can’t afford to lose, Egan said.

“One of the biggest problems is that newer investors see a ‘hot’ stock but don’t fully understand the implications of investing in that stock,” he said. “Many private investors could lose their shirts.”

Fotak said he read from a law school graduate who said he was thrilled with his victories at GameStop.

“He could now afford to repay his student loan,” said Fotak. “Yes, there is a lot of greed involved here.

“But there is also a lot of despair,” he added. “I really hope he sold straight away.”

Less short circuit?

Hedge funds that cut GameStop suffered huge losses when the group of day traders on Reddit bought the stock en masse and soared its price. Melvin Capital, for example, lost more than 50% in January.

Those setbacks could lead other investors to sell short or bet against stocks, experts say.

“After seeing several other funds being carried off the field on stretchers by these short positions, hedge fund managers will be much more cautious about which stocks they are willing to sell short,” said Sekera.

Less short selling means a less healthy market, Fotak said.

Bubbles are less common in countries where short sellers are less restricted, he said. This is because short sellers’ pessimism can offset optimism about a particular sector or stock.

“And in this climate with record market valuations, we need the opposing views of short sellers more than ever,” added Fotak.

Another benefit of short sellers is that they often cause serious problems for companies that other investors and regulators have overlooked, Fotak said.

“As they are looking for overvalued companies, they are always on the lookout for scams,” he said, adding that they frequently publish research into bad company practices.

And so it is unfortunate that the GameStop debacle could contain the short circuit, said Fotak.

“To the extent that the release of negative information is delayed, we all suffer from a less efficient market,” he said.

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