Academy Login

What Does the GameStop Kerfuffle Mean?

It’s been a pretty wild ride with GameStop. But while there has been a lot happening, does it actually mean much? We’ve examined the details of what happened elsewhere, so I’m going to focus on some of the bigger questions that this whole affair raises, and specifically how this all impacts long-term investors. So let’s start with the big one.

What does this mean for long term investors?

Not all that much. For all of the morality plays and media coverage, it just doesn’t have much of an impact on long-term investors.

As big of a story as this all was, it’s important to keep in mind that everything is contained to a relatively small group of small companies. We’re already seeing the prices of these companies come back into line with what we would “expect” to see, based on the company fundamentals.

When we’re focused on the performance of a globally diversified investment portfolio across decades, some crazy gyrations in a handful of small companies over the course of a week or so isn’t going to have a meaningful impact on your whether you will be able to meet your goals or not.

Does this mean the Financial Markets are Just Casinos?

Well, it depends on what you mean, but I would have said the same thing before WallStreetBets did their thing.

On a day-to-day basis you actually can’t tell the difference between the returns of a single stock and a coin flip. There’s simply too much randomness. It’s all but a 50/50 chance whether a stock will go up or down on any given day. But that “all but” is doing a huge amount of work. Because as we start looking at thousands of stocks from around the world over decades, those returns become less and less random.

There are fundamental risk and return relationships present in the financial markets that operate on long time scales over the market as a whole. We may not be able to say what returns will look like for the coming year, but we can make meaningful statements about what the broad shapes of returns will look like over the next decade or two.

Will I Need to Pay Attention to “Meme Stocks” in the Future?

As much fun as it is to hear reporters talk about “stonks” and badly edited gifs on WallStreetBets, probably not.

That said, I can imagine a world where stock trading is democratized through commission free trading and easier to use apps, where WallStreetBets (or whoever comes next) can point relatively large groups of investors in specific directions and influence (certain) market prices. But there are a couple of things to keep in mind:

  • It’s unclear how much of an effect the individual investors had in driving up the prices for GameStop and the other stocks. As a general statement, it’s tough to push market prices around. It requires bringing a lot of money to bare, and it wasn’t just Redditors pumping money into GameStop. There were a number of significant institutional players mixed up in this as well. It is likely that as people start pulling everything apart, this will start looking more and more like a “typical” (though pretty spectacular) institutional fight – just with a really good narrative laid on top.
  • There are some serious questions about the legality of everything that happened, and we are likely to see some sort of regulatory response (we’ll talk about this more a little bit later). Depending on how everything plays out, there is a chance that it could be more difficult for communities like WallStreetBets to coordinate like they have around GameStop et al. We could also see a response that would make institutional fights less common and/or less spectacular.
  • For as much coverage as this is getting, it’s important to keep things in perspective. GameStop and all of the other affected companies are really small. And while what we’ve been seeing has been massively disruptive for the affected stocks, it’s not really that important for the rest of the market.

To put some numbers around this, as of the end of the year, GameStop represented only 0.0026% of the Vanguard Total Market Index ETF (VTI). This means that for every $10,000 you invested in that fund you owned about 26 cents worth of GameStop. If we look at a small cap fund, in this case the Schwab Small Cap Index Fund (which tracks the Russell 2000 Index – a very common index of smaller stocks) only had 0.04% in GameStop at the end of the year. At GameStop’s top, it may have represented a few percentage points of this fund – and that fund likely would have only represented a few percentage points of your total portfolio.

In other words, all of this makes for a whole bunch of great stories, but it’s not something that will significantly impact many people.

Was Everything that Happened Legal?

It’s hard to say. Depending on who you listen to, people are saying that pretty much everyone involved is obviously guilty of every financial crime they have ever heard of. There are really three sides that we should discuss here.

First off, the hedge funds that were the initial targets of the short squeeze. People are making a lot out of the fact that GameStop was heavily shorted, and that more shares were shorted than there were shares outstanding. This gets held up as evidence of foul play, and admittedly it isn’t the best look, as you aren’t really supposed to be able to short a stock that you don’t own or know that you can purchase. If there are more shares being shorted than exist, that’s a problem. That said, the regulations around this have a whole lot of loopholes, and (so far) it appears that no one was (egregiously) breaking the rules. There may well be a tightening of the rules around short selling, but it’s important to remember that being able to short a stock actually helps markets operate effectively.

Next up, we can look at the individual investors, and specifically the WallStreetBets subreddit. There is a reasonable argument to be made that at least some of the people on WallStreetBets are guilty of market manipulation. The statutes are written very broadly, and it’s possible that some of the discussion/coordination (depending on your perspective) fits the definition of market manipulation (whether it should be considered manipulative is a different story). If it is determined that people on WallStreetBets (especially people who actually work in the finance industry and should know better)are guilty of market manipulation, or even if the SEC makes a show of investigating the possibility, then platforms are likely to take steps to prevent the type of discussion/coordination that we have seen.

Last up is Robinhood, the favored trading platform and custodian of WallStreetBets. During the height of the craze Robinhood restricted their users ability to purchase GameStop and certain other stocks. This was portrayed as a favor to the evil hedge funds, and people were a mite unhappy. The thing is though, they pretty much had to restrict trading in those names.

The reason for this is everyone’s favorite topic – trade settlement. Trade settlement is basically how security transactions actually happen. When you buy a stock, trade settlement is how do actually take ownership of it, and how the person selling it actually get your money. It’s riveting stuff as you might imagine.

Trade settlement, and custody in general, is pretty much the plumbing of the financial world. When things are running smoothly you don’t think much about the plumbing, but when stuff starts breaking you really care about the plumbing. And this is what Robinhood was running into. Rather than going into all of the details here, if you want the full story, take a look at these two Wall Street Journal articles: Why Did Robinhood Ground GameStop? Look at Clearing and Why Brokers Had to Restrain Trading in GameStop Shares.

In short, Robinhood got themselves into a position where they upset a lot of their customers, but they didn’t break any laws (so far as we know at this point).

Why is Short Selling OK?

Short selling is really easy to demonize. We don’t like the idea of profiting when other people are losing. But short selling is crucial to the markets operating effectively. At root, the financial markets are price discovery tools – they are there to make it easier for people to buy and sell securities. Short selling is a signal that an investor believes that a stock’s price is too high – just like buying a stock is a signal that an investor thinks that a stock’s price is too low. Short selling makes the markets more efficient by allowing information to propagate more effectively in the market.

It’s also worth pointing out that for long-term investors in passive funds, short selling is pretty much free money. Remember that when you sell a stock short you need to borrow the shares that you are shorting from somewhere. That somewhere is often passive funds – and they charge for the privilege of borrowing those shares. It’s not a huge amount of money, but it adds up. And, because they know that the share will be coming back, it doesn’t have any real impact on the performance of the fund (other than getting the little bump from the money they bring in through lending out securities).

Does this Mean the Bull Market is Over?

This is certainly reminiscent of some of the stuff that happened at the top of the market right before the tech crash. A lot of people have been talking about irrational exuberance again, but I’m not sure we can actually make this leap. It’s certainly possible that we’re at the top of the market and the bull market is over, but I don’t think anything we’ve seen lately gives us any information about that one way or another.

This is both because of the general statement that we can’t predict what the markets will do in the future, as well as a specific statement about this particular case. There are always bubbles, and just weird things happening in the market, it’s just that this was pretty much the perfect storm. The stock price shot up dramatically, there was a clear bad guy that everyone dislikes (hedge funds), and it lent itself to a very neat David vs Goliath type story. But normality seems to be returning. As I’m writing this after the market close on Thursday (February 4th, 2021), GameStop is worth a little less than $54. This is still a lot more than it was worth a month ago, but a lot less than it’s high of $483 that it hit a week ago. While we often focus on the financial markets as big impersonal things, it’s important to remember that they are made up of individuals. The financial markets really are markets. Over the long-term the fundamental risk and return relationships are what drives returns. But sometimes, over the short-term, people are dumb.

Have you heard
about the academy?

Everything we learn in school is to prepare us to have successful career. And the ultimate reward for that career — retirement. Yet when we reach that time, we’re thrown into the deep-end without any education on what to do. The Retirement Researcher Academy is a curriculum on retirement theory taught by some of the most respected professors in the industry.

Join us for a FREE webinar:

Travel in Retirement:

New Options and Opportunities

Hosted By

Dan Veto, CSA

Tuesday, July 23rd

1:00 - 2:00 PM ET

Reserve Your Spot and Register Today!