In this week’s market update: there is no doubt about the big market story this week - the David and Goliath tale of retail investors taking on powerful Wall Street hedge funds and apparently winning - the first round at least.
Some weeks a number of stories are vying for investors attention. Other times there is only one thing on everyone’s mind. And the last week has been one of those moments.
But before I get to it, some good news. The S&P 500 had its best day in more than two months yesterday, regaining the ground it lost last week in its worst week since October. It rose 1.6% while the Nasdaq was 2.6% higher as investors looked beyond the great GameStop drama to focus on an improving health situation as Covid hospitalisations start to fall and the outlook brightened for a bipartisan relief package. Shares also rose in Europe yesterday and across Asia overnight.
But back to the big story.
Most of us had probably never heard of GameStop until last week. We were probably unaware of the Wall Street Bets discussion board on Reddit. We almost certainly had a very sketchy knowledge of the SEC capital requirements of investment platforms. Well we’ve all become a lot more knowledgeable in recent days.
In the unlikely event that you have been hiding under a stone for the past week, here is a quick summary.
GameStop is a small, Texas-based bricks and mortar retailer of computer games equipment. It has largely been overtaken by the move online and has been loss-making. Hedge funds have consequently built up big short positions in its shares, betting that the price will fall further.
So far, so normal. But what happened next is unprecedented and tells a fascinating story about the changing face of financial markets in the age of social media.
Thanks to discussion groups on social media platforms like Reddit and the availability of very cheap share dealing services like Robinhood, it has become possible for groups of individual day-traders to co-ordinate their activities to greatly magnify their impact on the market.
This has occurred against a backdrop of anti-establishment populism that has fuelled animosity towards perceived financial elites who are seen to have prospered during the post-financial crisis period while others have struggled. Hedge funds are seen as a legitimate target in some quarters.
Again, nothing particularly new here. It’s as if the Occupy Wall Street movement has shifted from the physical streets to the online world of investment platforms. But the ability to convene groups of like-minded people on social media and to quickly share information has turned this formless anger into a concrete plan of action.
In recent weeks, groups of investors have encouraged each other to buy shares in GameStop and a handful of other struggling stocks in order to push their share prices higher. One of the apparent motives for doing this has not been simply to express an investment opinion but to squeeze the short-selling hedge funds out of their positions and make them suffer financially.
This is how the plan works. When an investor bets against a share, or shorts it, they borrow shares in the company from an existing holder, sell them in the market and hope that the price falls further so they can buy the shares back more cheaply, return the shares to the original owner and pocket the difference.
However, if the price goes the wrong way - which for a short seller is up - that short seller might find that in order to buy the shares back they have to pay more than they sold them for. This naturally results in a loss and, in theory, there is no limit to the size of the loss because there is no theoretical limit to how high a share can rise.
If you buy a share the most you can lose is what you have invested, and the gains are theoretically infinite. When you short a share, the reverse is true. The most you can do is double your money but there is no limit to what you can lose. This is why shorting tends to be the preserve of professional investors. It is very risky.
And this is why the co-ordinated actions in recent weeks are so potentially powerful. The price rises they cause can become self-fulfilling. The repurchase of shares by the squeezed hedge funds pushes the price higher again which encourages more people to buy the shares, which in turn squeezes other short sellers and so on and so on.
Because the participants in this stand off are largely uninterested in the fundamental value of the shares they are buying, the ensuing rise in the price can go to apparently excessive levels. This is what has happened at GameStop. Having traded below $10 a share, they briefly exceeded $400 a share last week.
Most people expect them to fall back to fair value again at some point. But no-one is quite sure when that will be or whether they could go much higher in the meantime.
The events of the past few weeks have raised some big questions for lots of different parties. For day traders the big gains have created a feeding frenzy and participants are quickly moving onto other potential targets.
This week’s focus has been the silver price which is seen as a target of short sellers and so vulnerable to the same attack. The price of silver rose by as much as 11% to $30 per ounce yesterday in London for its biggest one day gain since 2008. It rose 6% last week. The iShares Silver Trust, the world’s biggest silver-backed ETF, saw $1bn of inflows on Friday last week.
The other big question for day traders is when to get out of their winning positions because when the rapid price rises reverse as they surely will in due course, the falls could be equally fast.
For regulators, there are questions about whether the actions of the day traders constitute some form of market abuse. The legal position here is not clear.
For the investment platforms the requirement to post increasing amounts of capital with the clearing houses that sit between counterparties is a notable headache. Robinhood was forced last week to suspend trading in some heavily traded securities, including GameStop. It also had to raise money quickly from investors to help it meet its SEC obligations. Reputationally it has been a nightmare with the platform, accused of siding with the establishment against the interests of its customers.
For ordinary investors the question is whether the upsurge in speculative behaviour is a canary in the coalmine, foreshadowing market volatility to come and maybe the top of the cycle. In the past, this kind of speculative behaviour has signalled the end of bull markets. Most notably 20 years ago during the dot.com bubble.
For the hedge funds, the question is whether the risks involved in shorting stocks are worthwhile in this new world. And for the rest of us, this poses questions about the positive contribution negative points of view make to the price discovery process. You may not like short sellers, but they do help determine the right price for an asset and play a role in uncovering wrong-doing - think Wirecard and before than Enron and others.
So, lots of unanswered questions and a changed financial landscape now that individual investors have learned how powerful they might actually be.
That’s the main story this week. What else is happening. Well, there’s a torrent of company results this week as earnings season remains in full swing. In focus this week is technology again, with numbers due from both Amazon and Alphabet. Oil is in focus with BP and Shell. And pharma is in the spotlight with Pfizer and GlaxoSmithKline.
On the economic front, the big number is Friday’s non-farm payroll release in America. After last month’s disappointing fall in jobs, this month should be fractionally better but only just positive. Here it’s Bank of England monetary policy day on Thursday, with no change most likely.
But these other diary events are a sideshow compared to what most investors are watching this week, the remarkable stand-off between newly empowered retail investors and the big beasts of Wall Street.