The wave of Reddit rebels shaking Wall Street – from Tulip Mania to David – versus – Goliath

If you have spent anytime following financial news on social media over the last weeks, you will have been told fabulous stories ordinary people have had it with establishment Wall Street. They are furious at the way the banks were bailed out in 2008. They are angry about the amount of money made by the hedge fund industry. They have had enough of inequality, crony capitalism and a world where there is one rule for the rich and another for the poor. They are taking action.

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.

Gordon Gekko, the sharp-suited trader who came to epitomize Wall Street, famously said, “greed is good”. The army of retail investors who effectively coordinated on social media chat groups – the key Reddit group, r / WallStreetBets, has 4.8 million users – that has flooded into the shares of GameStop has taken Mr Gekko’s advice to heart, and turned it against Wall Street to great effect. The rush of money into what was an unloved stock has crushed some big hedge fund investors and signaled a new development in equity markets, where populism, social media and cheap money have combined to upset the status quo.

the flood of speculative retail money into GameStop shares rocketed so rapidly that the rise – more than 1700% in less than a month – looks like a series of typos: 19.95 USD on January 12, 76.79 USD on January 25, 147.98 USD on January 26 and 347.51 USD on January 27, with a peak of 483 USD in the morning of January 28.

That kind of action comes in the form of mass buying of shares that the hedge fund industry has bet against. It’s very clever. Once you have got the share price rising even a little, you force those who have bet against it – by borrowing some shares, and hoping to sell and repurchase them more cheaply – to buy them, too, to cut their losses. This pushes the share price higher very, very fast. Rinse and repeat.

That means pain for the hedge funds or “Wall Street” as their trading losses were around 5 billion dollar. The price of GameStop started falling, as retail platforms like Charles Schwab, TD Ameritrade, Robinhood and Interactive Brokers curbed trading in the stock. The stock’s gains obviously 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 or high-speed Wi-Fi?

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 like these, most long-term investors are usually better off if they stay sober and avoid the urge to make quick profits. A better option in our opinion would be salting away money in dull, well – diversified stock and bond portfolios, these days preferably in low-cost index funds. Trading in stocks like GameStop is the last thing people should be doing.

As a fight back against Wall Street, it is hopeless. The money that banks and fund managers make comes mainly from trading commission and fees – not from their investment performance. If they relied on that, there wouldn’t be a rich person left in New York or the City of London.

As a way to shift wealth, it is equally useless. At some point, fundamentals – based valuations will reassert themselves and the many small investors left in the game will lose a terrifying amount of money. We at Calvin • Farel have no idea what GameStop is worth but we know that, unless the share price is a hyperinflation canary, it most certainly is not 13 billion dollar. Pushing up the price can’t change the value.

The truth is that, despite the passionate open letters on Reddit urging users to take a “once in a lifetime opportunity to punish the sort of people who caused so much pain and stress a decade ago”, the social justice story is probably just that: a story.

The real drivers here – and in most market action, by the way – are the availability of money and the longing for more money.

The collapse of one money – losing hedge fund – Long Term Capital Management (LTCM) – sent unexpected tremors through global markets back in 1998. But that is exactly the kind of thing that regulators will be looking for now, as it exposed a number of regulatory and supervisory gaps. The authorities were caught asleep at the wheel – again. They now need to resolve a series of difficult and, in some cases, competing issues that range from investor protection to market collusion.

There also has been a flood of initial public offerings (IPOs), particularly of entities known as SPACs, short for special purpose acquisition companies; we describe them as “publicly traded shell companies created solely to merge with a privately held business”.

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 last year 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 – big government spending programs – has made up for some of the income of millions of unemployed people and thousands of failing businesses.

Thanks in no small part of the infusion of money, asset prices across the board have risen, and interest rates remain extraordinarily low. Big Tech stocks like Apple, Microsoft and Facebook including Amazon and Alphabet have fueled the rally, helping to make stocks expensive by historical measures. But if corporate earnings rise as expected – we most probably can anticipate a year – over – year increase that could range between 20 to 40%, given the devastation wrecked by the pandemic in 2020 – the stock market may seem less outrageously priced.

Low interest rates make stocks attractive, compared with alternatives like bonds, many strategists say, but that could in our opinion change. We for now expect the bull market to live on but that if the yield on the benchmark 10 – year Treasury note, now a little above 1%, reached 1.5% or even 1.75%, there could in our opinion be a severe stock market reaction, much as there was in 2013 and again in 2016. Such a rise is unlikely but still 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. We will explain that in more detail in a separate article.

Truly long-turn investors may in our opinion not need to worry about such issues too much, however. The great temptation in a rising market like the recent one may be to buy soaring stocks, for fear of missing out (FOMO) on easy profits. The temptation during severe downturns, like the one a little more than a year ago, is to sell your holdings to avoid big losses. We at Calvin • farel believe in setting a steady course and sticking with it often for many years by holding stocks and bonds in an allocation we can comfortably live with, and by ignoring the GameStop madness.

We still suggest: “Tighten your seat belts as there will be a rocky ride ahead.”