Can the Gamestop Saga Crash the Stock Market?

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On a wall in our apartment is a section covered with post-its that both FIRECracker and I use to store potential article ideas. On one pink post-it are the words “Robinhood + Gamestop” I had put up there a few weeks ago when I had noticed something strange happening on the financial markets. Back then, there was a strange amount of chatter and interest in a random stock, Gamestop, for seemingly no reason. Similar things had been happening to other companies like AMC and Blackberry, and it was causing their stocks to spike to the complete surprise of the people running those companies. And I thought: Oh, that might be an interesting idea for an article.

Jeez Louise, that story blew the Hell up, didn’t it?

As of the time of this writing, the trading frenzy on Gamestop (GME) has made it one of the most heavily traded stocks in the US.

And on top of that, this story has taken on an almost mythological feel, entangling a fascinating cast of some of the most influential people in the investing world, including Michael Burry, Elon Musk, Wall Street hedge fund traders, a fintech company called Robinhood, Alexandria Ocasio-Cortez and Ted Bloody Cruz. To be honest, I’m kind of surprised Trump’s not involved, because when a story is this bizarre, he’s usually in there somewhere.

Ooookie dokie. So how do we even start untangling this mess…

How Did This Start?

In 2020, Gamestop became one of the most shorted stocks in the entire market. At the time, Gamestop, a video game retailer, had already been experiencing declining fortunes because of the video game industry’s transition away from physical distribution into digital downloads. Then the pandemic hit, shutting shopping malls down all around the world. So when hedge funds started taking up short positions and betting that Gamestop’s stock would go down, they did it for fairly rational reasons.

Enter Michael Burry.

Michael Burry is the hedge fund trader who famously predicted the 2008/2009 Great Financial Crisis by shorting the US housing market. He also had his story adapted into a movie The Big Short where he was played by Christian Bale.

In April 2020, Michael Burry invested $15 million in Gamestop’s stock, with the intention of restructuring the company into a digital distribution hub. He was joined later on in the year by e-commerce CEO Ryan Cohen, who invested an additional $76 million into the company. By the end of the year, against all odds, Gamestop’s stock price had doubled, then tripled. Despite the fact that very little about the company had actually been changed.

So already, this is an interesting story. Remember that this is the same Michael Burry who claimed passive investing was distorting the market because nobody was actively investing anymore. So of course he then turns around and actively invests in this stock, inadvertantly setting into motion one of the biggest price distortions in the history of the stock market. Suuuure, Michael. It’s the indexers that are screwing the market up.

But the story doesn’t end there. It’s just getting started.

At some point, a Reddit user named DeepF*ckingValue noticed the trading volume on Gamestop and agreed with Michael Burry and Ryan Cohen, dumping his entire life savings into Gamestop. He then documented his bet on the reddit subforum r/WallStreetBets. That’s when the story took on a whole new leg.

These three initial players were arguably just doing what any value investors do. They saw a stock in decline, believed that the company could be turned around, and bet accordingly. But when this story hit Reddit, it somehow morphed into an epic battle in class warfare.

One one side of the trade were the big, rich Wall Street hedge fund fat-cats who were trying to manipulate the stock to their benefit. And on the other were the plucky Joe Everymen sick of the stock market only benefitting the rich. The Redditors started egging each other on, convincing each other to plough their life savings (known as YOLO-ing), causing the stock’s price to continue to rise and denying the short sellers their payday.

To everyone’s surprise, this tactic was so successful that it created a situation known as a short-squeeze. Basically, when an investor shorts a stock, they borrow the share for a specific amount of time and sell it (hence the term short sale). Later on when the borrowing period expires, they have to buy their share back to return to the lender, and if the stock is trading at a lower price at that time, they’ll be able to pick it up for cheaper than what they sold it for, pocketing the difference as profit.

But now there were so many Redditors buying the stock and pushing it’s price up that when the short sellers were forced to re-buy their shares, they were forced to buy at a higher price, which caused them to lose money. It also inadvertantly pushes the stock’s price even higher, which made the situation even worse for their other short positions. The hedge funds started hemmoraging money to the tune of millions, then billions of dollars.

Then Elon Musk, who famously hates short sellers (because of what they tried to do to Tesla’s stock), saw what was happening as the hedge fund managers started whining to the media, thought it was hilarious, and gleefully piled in, tweeting out the following:

Classic.

Following that tweet, the stock instantly doubled in value again.

Why Did it Become Such a Huge Story?

At the time of this writing, in 2020 Gamestop went from $6 to $325, or a gain of over 5000%. It got so crazy that at one point the hedge funds managed to pressure the trading platform Robinhood into locking out their users from buying any more shares of Gamestop. They were still allowed to sell, but not buy.

Then all Hell broke loose. The Redditors were screaming that Robinhood was blocking them from making money. The hedge funds were whining that the government should step in and regulate the Redditors.

It got to a point where an unholy alliance formed between Alexandria Ocasio-Cortez and Sen. Ted Cruz to force Robinhood to unblock trading, but for completely different reasons. AOC objected to Robinhood placing their thumbs on the scale in favour of Wall Street over retail investors. And Ted Cruz objected to any disruptions of the free market.

The poor were literally robbing the rich, all via an app called Robinhood. You can’t make this shit up.

What started as an esoteric trade between a famous value investor and Wall Street hedge funds somehow turned into…well, whatever this is…

WE’RE IN THE ENDGAME NOW from r/wallstreetbets

I honestly can’t decide what part of that video was my favourite. Is it Elon Musk floating in like Space Jesus? Is it AOC buzzing around like a goddamned firefly? Or is it the Wakandans yelling “DIAMOND HANDS”? (Diamond Hands, by the way, is their bizarre way of saying “Hold your positions.”)

Also, did Captain America grab a Stimulus Check back there before going into battle? Are people throwing their pandemic relief payments at this? Hoo Mama…

How’s This Going To End?

Here’s the thing. At GME’s current stock price of $325, it implies a market cap of $23 billion. Gamestop is not a $23 billion company. Not even close.

There is no universe in which the stock simply stays at this level and everyone just goes back to work. It’s going to have to crash back down.

But this is no longer a story about valuation, it’s a story about emotions. Both the Redditors and the Wall Streeters can’t back down, and both are poring money into their respective trades hoping the other side backs down first. This is now a dick-measuring contest, and the winner will be forever crowned as the BSD, or Big Swinging Dick. I didn’t make that term up, by the way. That’s their terminology, not mine.

So who’s going to win? Who knows? The only think I know for sure is that the stock’s going to crash. But I have no idea when.

How Does This Affect You?

Well, first of all, to all the readers of this blog who’ve followed our advice and invested the majority of their money in passive index-hugging ETFs, there’s good news. It turns out the death of the active investor has been, as they say, wildly exaggerated. Remember that passive investing actually needs people betting on individual securities to work, so this past week has, if anything, been a ringing endorsement that indexing will not only continue to work but is the only safe way for retail investors like you and me to invest in the stock market.

Secondly, does Gamestop have the potential of destabilizing the entire stock market?

In short, no. While it might cause short term volatility, these kinds of bets just don’t have the volume to affect the stock market as a whole. Even if Gamestop were to cease to exist and wipe $23 billion off the face of the earth, the S&P 500 alone is worth a total market cap of $32 TRILLION. Gamestop isn’t even worth 0.1% of that.

However, just because the indexers won’t be affected, you may be. In the shorter term, everyone can expect to be bombarded with messages from all directions to abandon index funds and instead put as much money into GameStop as possible. Here’s why.

While the hedge funds have a clear exit strategy (wait until the Redditors capitulate and then ride the short wave all the way down), the Redditors don’t. Let’s say the hedge funds all throw in the towel and stop shorting Gamestop. Then what?

Then a whole lot of these people will be at first cheering, seeing their multi-million balances in their Robinhood account in way, way, way overvalued GME stock. But if they actually want to realize their gains and cash out, they will have to sell them. But to who?

Nobody actually believes Gamestop is worth $325 a share. The main reason that people kept piling in was because they believed there was money to be made by maintaining the short-squeeze position against the hedge funds. After that position disappears, the minute one person tries to cash out, everyone will rush to the exits and the stock will crash back down to earth.

The only exit strategy for these people that makes any sense is to continue spreading rumors after the short sellers are gone that the share is going to continue to skyrocket in order to keep bringing new buyers in. At the same time, the existing owners will secretely sell to those new buyers behind their backs to cash out, leaving their new owners holding worthless shares. So while Phase 1 of their “plan” is to engage in a dick-measuring contest with the hedge funds, this will eventually transition into Phase 2, which is to turn the stock into a giant Ponzi scheme while quietly exiting their positions.

Don’t be fooled by the narratives being pumped by the media. There are no good guys and bad guys here. Everyone’s a bad guy. The hedge funds are trying to screw the retail investors, and the retail investors will eventually try to screw other retailer investors (i.e. you).

While Gamestop seems like a runaway freight train, us indexers are more like a peaceful blimp, floating above the fray and looking down at the mayhem with binoculars. As long as we stay up here in the clouds, we’ll be fine. But make no mistake: there’s only one way the Gamestop saga ends and it’s in a train wreck. Do not under any circumstances get on the train.


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31 thoughts on “Can the Gamestop Saga Crash the Stock Market?”

  1. That clip is MAGNIFICENT. I hear the next big thing (as of, what, four days ago?) is squeezing silver; got a few pounds of old eBay’d 925 flatware I’ve been meaning to divest…

  2. I so totally agree with your analysis! Here’s a question: can’t you replace Gamestop with cryptocurrency in the analysis and make the exact same argument? Except, I guess, that you can’t short crypto. Still feels like a pyramid scheme. I’ll stick with my index funds.

  3. Thanks for this! It makes a lot of sense, hard not to get caught up in the circus and worry that I am missing something. I appreciate the analysis and advice 😀

  4. Getting tired of this same news, same explanation of what’s shorting, what’s GME, what’s going on,,,c’mon people !

  5. “Also, did Captain America grab a Stimulus Check back there before going into battle? Are people throwing their pandemic relief payments at this? Hoo Mama…”

    You bet they are. YOLO-ing their stimmies to get their tendies.

  6. Wow I love that video 🙂 To add to the story, Robinhood posted a statement last week saying that they weren’t caving into pressure from hedge funds or other parties, but they had to restrict trading because the demand for some of these stocks was so high, _they didn’t have enough funds to cover it_! (Robinhood blog post: https://blog.robinhood.com/news/2021/1/29/what-happened-this-week) Sounds like the Redditors broke the brokerage too.

  7. I’m watching this game with more than a little bit of amusement. There will be no winners here. The GME business is a freaking dinosaur and as a dinosaur I should know (I’m 70).

    Several years ago it made at least a modicum of sense to buy GME. They were paying a 23% dividend, which of course was unsustainable given they were losing money hand over fist.

    But now? Now this is the new version of pump and dump, with the uncomfortable fact that those doing the pumping will be hurt badly when the stock crashes.

    If you’re going to YOLO do so in an index fund like VTI. I did in 2019 and have no complaints.

  8. Could this saga crash the market if the redditors don’t give in before the shorts come due, forcing the hedge funds to liquidate their long positions to cover their shorts? I thought this situation (and the endless memes about it, it’s become the new Bernie’s mittens) was really funny until heard about that possibility!
    Thanks for the thorough explanation, all the others I’ve read left out the bit about Burry, and left out Elon’s motivation, blaming the entire situation on angry redditors

    1. The ‘request edit’ button isn’t working for me
      * forcing the hedge funds to liquidate their long positions to cover their shorts, causing others in the market to panic and sell

  9. Wanderer, thank you for this great analysis. My one fear is if hedge funds keep trying to short GME, their losses are potentially unlimited and that would force them to sell good stocks. I heard that this is why there was a 3% overall market dip at the end of last week. So even though GME’s only 1/1000 of the total market (at those lofty valuations) the shorting itself can still potentially cause tremendous damage. I’m with Musk and wish shorting would just be banned. What hedge funds are doing is pure gambling, not investing, and that belongs only in a Las Vegas casino imho. Wall Street’s “smart money” is basically endangering all our investments, even in index funds, due to their greed and ego ☹️

    1. That is a great scenario for us passive investors. Buy the market when it just went down 2%.

      And if the hedge funds are selling “good” stocks for less, let someone else buy and have those stocks.

      For me the whole idea of playing the index, long game is that in the very long term I do believe the market is smart. Bad companies will persish and good companies will succeed. In the very long term you do need to have a product to sell that makes more moeny than it costs – you need profit at some point in time.

      In the short term, of course, those kind of games we are seeing can happen. As a long termer, I couldn’t care less who trades what stock today and for how much. I have them all, and those who will survive for the next 20 years and still make money will be the ones in the index in 20 years time.

      Everything in the middle is noise.

      This is noise.

      Entertaining noise, but still noise.

  10. Question to the lawyers: if the scenarion that Wanderer describes will actually happen, wouldn’t that be classified as market manipulation?

    If the Redditors who initially encouraged in public forums to buy and holdGME, then continue in a public forum to pump the stock while at the same time selling it, is it in any way an illegal activity?

    It sounds to me exactly like what some of those scummy hedge funds are doing, but those hedge funds have armies of lobbists and lawyers to protect them…

  11. May I please have your unlimited permission to make use of your phrase in an age-appropriate venue, maybe a faculty meeting: “So while Phase 1 of their “plan” is to engage in a dick-measuring contest with the hedge funds…”?

    Maybe it could be something like: “Madam Chair, if you are engaging in a dick-measuring contest, might I remind you that only one of the two of us in this tête-à-tête possesses such an appendage.”

    Maybe I could win an award for my brilliant rhetoric!

    Standing by waiting for your signed permission to make use of your inspired use of the phrase “dick-measuring contest”! Thank you in advance!

    Dan V, Ph.D.
    Taipei, Taiwan

  12. While I normally don’t get involved in single stock picking or day trading, I did dip my toe in this arena just to experience what stock volatility like that is like with basically gambling an amount I was prepared to go to zero. It was definitely a wild ride for a day. I did profit, but it was certainly random dumb luck. I immediately put those winnings back into low cost index funds.

  13. I’m not convinced that AOC got into an alliance of any kind with Ted Bloody Cruz. I thought she told him to resign? They may be on the same side about this for different reasons. But an alliance it is not.

  14. Won’t the financial ruin of all those ‘regular’ people cause a massive deficit in consumer purchases?
    And since that usually triggers the economic crashes every decade, since that’s a normal part of capitalism, couldn’t it still cause a crash too?
    It might be for an entirely different reason than the one you would expect, but a crash is still a crash.

  15. I love how retail investors are now making big enough noises now to where the whole world actually know and care about their existence.

    However, as much as how I loved retail investors winning vs the hedge funds, I knew as you’ve highlighted, that GameStop was not worth $24B. At some point valuation does follow the law of gravity, though the market can stay irrational longer than others can stay solvent.

  16. Great summary. Big fan of your writing Wanderer. Where did you find that wonderful Avengers Endgame gif?

    Michael Burry from the movie “The Big Short” was coincidentally long on GME. I wonder if he cashed in his positions knowing this is once in a lifetime opportunity. Any thoughts here Wanderer?

  17. When it comes to Wall Street 99% of the population in anywhere on the planet earth are playing the musical chair game (with just ONE CHAIR calculated with Math+Psychology).

    Most of us do not have the desire (passion) NOR the skill to manage the risks into the acceptable range. It is greed and childish compulsive behavior that will eventually leave you standing without a chair.

    Good luck kids!

  18. Great post. While we like to stay away from the daily news (too much negative return from our time investment – pun intended :D), we could not skip that one as it made every single possible headline for a few days. So reading your post was of great education/entertainment value about this!

    We did however use some free money we got deposited our Robinhood account when we opened it up back in 2018 to get some #DodgeCoins just to see if we could become millionaires overnight, especially since Elon mentioned it at some point! We only bought $20 worth of that crypto and while we are already up, we are still far from hitting millionaire status (a second time!). But we won’t midn keeping you posted if you do so! #FOMO

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