We all know the biblical story of David and Goliath. David, a lowly Israeli shepherd, armed with just a sling, took on a Philistine giant, thereby defeating the Philistines in a single combat. Political scientists and business gurus have attempted to draw lessons from this epic battle: size does not matter, believe it’s possible and don’t underestimate your capabilities.
Perhaps these lessons were not lost on the more than eight million members of “WallStreetBets”, a community on the platform Redditt, when they decided to take on some mighty hedge funds that where shorting stock of companies that had seen better days like GameStock and American Media Corporation.
Before I lose some readers, who are not versed in “shorting”, lets go by parts. First off what is shorting? It’s a fairly simple concept – a seasoned investor like a hedge fund identifies a vulnerable company that it believes is overvalued. It then borrows the company’s stock (at a commission), sells the stock and then buys the stock back (at a lower price) to return it to the lender. They sell high and buy low, pocketing the difference in return.
GameStop became one of WallStreetBets’ members prime targets. It was a struggling video game company whose stock price was worth just a few dollars in 2020 Yet in one week, the stock that had been trading at around $18 peaked at just over $480, a price that topped that of some members of the S&P 500. How did a company considered by many to be in its death throes become the centre of an epic struggle between some Wall Street titans and vigilante day traders?
Millions of followers on the Reddit forum “WallStreetBets”, a community dedicated to giving advice on stocks, were able to communicate with one another and co-ordinate an assault on the hedge funds who were shorting the stock. The app Robinhood, in turn, provided the crucial digital infrastructure to execute such an attack. This zero-fee online brokerage platform allows ordinary people to buy shares in companies for small amounts of cash from their phones. The stage was set for an attack on Wall Street. WallStreetBets publicly hatched a plan on the forum to buy and hold GameStop stock and GameStop call options in order to drive the price up so high, that it would create a “short squeeze”, making it prohibitively expensive for the hedge fund to buy back the shares that they had sold.
Melvin Capital, one of the hedge funds in question, felt the squeeze. It lost $2.75 billion, in the first few days, and had to be bailed out. On the up-side three of the largest shareholders in the video game store GameStop made more than $2 billion. All the media coverage this event was receiving only served to attract more traders to buy GameStop stock. Was the little man finally having his moment in the sun? Was this a classic David and Goliath story about small investors taking revenge on a financial system rigged in favour of the wealthy?
Like any good saga, the story did not end there. As of writing, GameStop’s stock had plummeted to around $90, removing all gains made by most of those who bet against the Hedge Funds shortsellers and had not sold their shares.
How did this happen and more importantly what does it tell us?
The how has been partially answered. Technology has democratised investing. On-line brokerage apps like Robinhood allows anyone with access to a mobile phone to become an investor. Social media platforms such as Reddit allow millions of small investors to communicate with one another and to consolidate their buying power.
No single cause motivated this rebellion of profane, irreverent degenerates – their words not mine – spearheaded by someone who goes by the name of DeepF—ingValue. Some were moved by anger and frustration at the financial system that was never held properly accountable for the financial disaster of 2007/8. Others were playing a purely speculative game. Faced with social confinements and cash in hands, from the stimulus measures to combat the pandemic, they had the time and means to gamble.
More interesting is what does this all mean? There is little doubt that things have changed. Social media and no fee brokerage have not only democratised stock market investments, but they permit flash mobs to dictate the value of a company in a matter of hours. They also permit other Wall Street titans to know the trading plans of thousands of retail investors and get in on the action. It is no wonder that it was another well-known asset management firm Citadel Securities that landed up injecting money into Melvin Capital. This is hardly David vs. Goliath, more like a Goliath vs Goliath.
Flash mobs are dangerous. They contribute to extraordinary volatility in the stock market, whilst pushing the value of a company far from its “fair value”. For those that believe that the purpose of the stock market is to allocate capital to productive businesses, this is cause for concern. Speculative bubbles may become more common leading to a misallocation of capital. All of this raises tricky questions about market efficiency, regulation and financial stability. Senator Elizabeth Warren, one of the more ferocious critics of market speculation, is now calling for greater regulation.
Others, myself included, view the stock market as having become a place of wealth creation for the more privileged members of society and less a way to channel money into productive investment. Speculation and gambling, I’m afraid to say, is “business as usual” and has existed since finance itself. What has changed is the ability of the small investors to get in on the action.
In either case, the divorce between market valuations and economic or corporate fundamentals will not last forever. All bubbles ultimately burst and this particular one landed up being of very short duration. As of writing, the stock in GameStop has taken a dive to around $90, falling almost $400 in one week.
Are we witnessing the Russian revolution of finance, where the financial proletariat is rising up to change the establishedl financial order? I very much doubt it. Most revolutions are spearheaded by elites, that wish to see themselves in power. Whilst GameStop has been depicted as a kind of populist revolt of the masses against the “greed” of the traditional Wall Street actors, it was led by a few shrewd investors willing to sacrifice less experienced investors (the masses) to make a quick buck. Other hedge funds and management funds, played on the naivete and idealism of those who kept on buying shares in GameStop to buy, hold and then offload shares and make a hefty profit.
What we are seeing is the internet being used as an instrument to gang up against the establishment. In the future, the big guys will have to keep their eye on social media and will use social media to further manipulate the market, instead of being a victim of it. But GameStop has started a trend. Small investor access to financial markets is here to stay and social media dynamics allows them to pool their strength like never before.
This is just one more instance of social media facilitating a revolution, by helping to coordinate the actions millions of people. The Arab Spring, commemorating its 10th anniversary, is just one example. More recently, the “gilets jaunes” in France, demonstrations against Chinese rule in Hong Kong, the surge on Capitol Hill in the US, the examples are many. It is no wonder that authoritarian states shut down the internet and social media platforms as soon as a demonstration is brewing.
However, this “revolution” has now hit the financial world. Retail investors won’t always come out on top. Lacking the financial knowledge of hedge funds, millions of small investors seduced by quick wins or making a point may often stand to lose. Regulatory authorities may step in. If you invest just to “stick it” to the Man, you may find yourself without a shirt.
Many people have not forgotten nor forgiven what happened in 2008, where millions lost their jobs or homes. Millennials can now afford to join the fray. They won’t be silenced and they want a greater share of the pie. They are attempting to hit back where it hurts the most.
In the GameStop frenzy, David did not beat Goliath. He may have wounded him. He certainly made himself noticed but he did not become the reigning king like in the biblical story. At the end of the day, it was a story about Goliath vs. Goliath, with David playing the warm-up act.