Feb. 2021: Game (Will) Stop

February 1, 2021

By Mark Oelschlager, CFA

On seemingly everyone’s lips the last couple weeks is the performance of GameStop (GME) stock, whose meteoric rise in such a short period is an exceedingly rare event for any stock. As we write this, the stock is up 1529% since January 12. Other similar stocks - businesses that were in secular decline and whose stocks were heavily shorted – have seen spectacular spikes as well.

The rally before the rally in GME started with the announcement of a new board member in September. As the stock continued to move higher in mid-January there was a “short squeeze,” in which investors who are short the stock (betting it will go down) are forced to cover their short by buying shares, forcing the price even higher, and so on. The trading in GME and others of its ilk is being dominated by retail traders that congregate in online chat rooms, the most well-known being Reddit’s WallStreetBets, and essentially band together to drive a stock’s price up. Their actions may or may not be legal. Many of them use the popular Robinhood app to trade. These traders are specifically targeting stocks with high levels of short interest. Some examples are AMC Theatres, Koss Corporation, Express, and BlackBerry. All have risen dramatically this year.

Our read on this is that there are two motivating factors at work here, though it’s difficult to properly apportion between the two. First, of course is the desire to make money. Second, given many of the comments and threats by the participants, is revenge. There is a generational conflict at play, with the young-adult crowd relishing their chance to stick it to the Baby Boomers, whom they believe were responsible for the 2008 financial crisis that caused so much economic pain.

A well-known short-seller in the industry that was short GME encountered threats to not only himself but his family. In response he decided to no longer publish short-seller reports, which would be akin to McDonald’s deciding to stop selling hamburgers. New York Mets owner Steve Cohen closed his Twitter account upon receiving threats when he provided hedge fund Melvin Capital with a large capital infusion after Melvin had suffered large losses on short positions.

Of course, as the prices of these stocks continued to climb and more and more people hear about the game, the number of players increases, which provides more fuel for the raging fire. This is reminiscent of the day trading phenomenon of the late 1990s and its effect on a subgroup of tech stocks. The moves in the current crop of stocks are not based on fundamentals but rather the greater fool theory: the hope that someone will be willing to buy at a higher price than what prevails today. We believe this is a dangerous game to play and is not investing. People seem to know this but play anyway.

The market capitalization (the total value of its shares outstanding) of AMC is about eight times higher than it was pre-pandemic. This just doesn’t make sense. Some companies are taking advantage of the gift the market has given them and are issuing shares at these higher prices to shore up their balance sheets. In addition, some company executives are wisely selling shares that they own personally.

When will the game stop? Nothing is certain in this business, but it looks highly probable that the fire will eventually run out of fuel, and the prices of these stocks will return to a much lower level – one that more closely reflects the intrinsic value of their businesses.

Two of the causes of these events are the loose monetary policy of the Federal Reserve and the sharp increase in federal spending. This group of stocks is just the latest sub-market that has developed into a speculative bubble, and we are likely to see other bubbles form until the Fed changes, or at least talks about changing, its current strategy. Please note: Currently these investments are not a part of the Towpath Focus Fund or Towpath Technology Fund portfolios.

Mark Oelschlager, CFA Oelschlager Investments

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