GameStop, AMC & "Short Squeeze"...What does it all mean?
February 2021 - Last week was a rather eventful one in the stock market, with the spotlight on a handful of stocks that took the market for a rollercoaster ride. Companies like AMC Entertainment (AMC) and Blackberry (BB) saw trading volumes rise to unprecedented levels, all driven and led by the mania surrounding GameStop (GME), which soared from $18 to nearly $470 at one point in time in the month of January alone. Rarely do events in the financial world make it to mainstream TV outlets, but GameStop was unique, even making an appearance on Saturday Night Live this past weekend. Here is a quick rundown of what happened and our take on how it relates to the broader market.
What prompted last week’s action apparently stemmed from one person’s investment opinion from the summer of 2020 on the Reddit internet forum, WallStreetBets (although there is a theory that other investors like hedge funds who stood to benefit from a large move in the stock price of GameStop fueled the conversation as well). Reddit is an online message board, predominately used by millennials, containing thousands of forums on subjects such as art, politics, science, computers, and finance. WallStreetBets is the name of one of the forums, or “sub-reddits”, which has historically been a place to discuss stock-picking ideas. This individual’s view was that GME is undervalued and should be bought under the notion that it is the only place to physically buy a video game, injecting a sense of “nostalgia” into the investment thesis. GME’s mall-based retail stores have been struggling over the past few years as the video game industry moved towards direct downloads, eliminating the need to go to a store. Several high-profile hedge funds were short GME, meaning they sold shares on the bet that they would fall further before they would be required to buy them back, and thus take a gain on the lower stock price. The short thesis was based on the idea that GameStop’s business was dying, and the company may at some point file for bankruptcy. The total short position in GME was notable at 140% of the shares available to trade. You might be asking “how can you short more shares than there are shares available?” This is part of the problem, as brokerage firms may allow “naked” shorting by which you can indeed sell a share short without needing to physically borrow a share. Although this is prohibited there are often loopholes in the rules.
As the level of the total short position became increasingly known to the Reddit community, the interest in GME quickly rose. WallStreetBets became the epicenter of an opposing force to the large, multi-billion-dollar hedge funds which remained short. While some within the Reddit forum provided some loose rationale for why GameStop was undervalued, many of the posts within the forum became largely geared towards disrupting Wall Street and contained hateful commentary targeting billionaire short sellers. In little time, Reddit users began buying on “free” trading platforms like Robinhood, pushing the shares higher and causing short sellers to buy back in to cover their positions, known as a “short squeeze”. As a result, GME stock soared, as did others in a similar situation such as AMC Theaters and Blackberry.
Robinhood briefly limited buying in many of these stocks last week as its official position was that it was required to contribute additional capital to its clearing firm. The alternate theory is that because Robinhood is partially owned by a firm with interests in short selling firms, it did this to help its friends.
While this was a fascinating story on many fronts, we are unsure that much will change. If anything, when events like this have happened in the past, guard rails are placed on individual investors to protect them from losses. Indeed, last week’s events did create volatility as hedge funds with exposure needed to sell winners to cover substantial losses. However, the total market cap of the companies involved is miniscule as it relates to the broader market and it appears the Reddit traders have already moved on to other ideas.
This communication is prepared and distributed by AMI Asset Management (AMI), an SEC-registered investment adviser. The information contained herein and the opinions expressed are those of AMI as of the date of writing, prepared solely for general informational and discussion purposes. The information contained in this communication has been compiled by AMI from sources believed to be reliable; however, AMI does not make any representation as to their accuracy, completeness or correctness and does not accept liability for any loss arising from the use hereof. Such information and opinions are subject to change without notice due to changes in market or economic conditions and may not necessarily come to pass. References to specific securities are not intended as recommendations of said securities. The reader should not assume that any investments in securities, sectors and markets identified or described were or will be profitable. Investing entails risks, including possible loss of principal. Past performance is not a guide to future performance and future returns are not guaranteed.
Simplifying The Path Towards A Secure Future.
As your financial partner, our mission is to provide you the information you need to make the choices that matter most in your life.
After closing at a record high yesterday, the Standard & Poor's 500 stock index dropped about seven-tenths of 1% today. The index returned 5.2% in April -- more than five times the monthly gain stocks averaged for nine decades.