The Next Now: the internet vs the mega rich
If you’re reading this newsletter, you’ve probably at least caught wind of GameStop’s (NYSE: GME) stock hitting $347, rising from $17 just a week ago. Before we talk about the implications of this, let’s look at how we got here.
GameStop, objectively, is a dying business. For those not familiar with GameStop, you might be familiar with the EB Games brand, which is one and the same. The business model in question is becoming increasingly irrelevant, and this is happening quite fast. It will almost surely go the way of Virgin record stores or with lesser direct relation, Blockbuster. Why? Microsoft and Sony are pouring hundreds of millions into a focus on subscription based digital distribution for their video games consoles. On PC, buying a physical game on a disc has long been passé. I’ll save a deep dive on games distribution for the next unavoidable controversy on that topic, but it’s important to know that without a stark business pivot - one that will leave GameStop looking like a very different company - it’s not one many people would recommend you invest in.
So with that in mind, how did GameStop just reach a market cap north of $24 billion, seeing 1700% gains in such a tiny window of time?
Sticking it to the man
Fundamentally, for not much other reason than a middle finger to ‘the establishment’. On January 11 GameStop appointed three new directors to its board. As a result, optimism for the company’s future was renewed amongst a small number of bulls, and the price saw a positive bump. Savvier hedge funds understood the company’s ultimate fate and that it’s unlikely a few new directors will turn it around. So, they decided to bet against it; they shorted it. That is to say, they leveraged a mechanism for making a ton of money as GameStop’s share price falls, with the seemingly trivial risk of the shares going much further up - in which case, they would lose in big ways. However, numerous voices would argue that these aggressive short positions, which in this case accounted for more stock than existed, are reflective of a broken system.
Reddit would agree, it has become abundantly clear, where a notoriously hilarious and noisy WallStreetBets trading community, otherwise known as WSB, decided they didn’t want to let billionaires profit greatly by betting on a catastrophic end to GameStop’s operation. Instead, they rallied together to pump up the GameStop price to spite those hedge funds. The theory underpinning their willingness to do so is that short-sellers will have to then begin buying to cover their losing bids, or risk going bankrupt. The result would be a further driving up of the price, with all of those Redditors profiting. Where would that end, though, and when? More on this soon.
How can such pressure be sustained? How can ‘the internet’ raise a failing company’s value by $17 billion - irrationally so - and then sustain that irrationality longer than the period of time these hedge funds can stay liquid? It has long been suspected WSB is quite literally influencing the market, however this is the first time it has been proven true in no uncertain terms. The first thing you need to understand is that these aren’t just kids with pocket money trading via zero-fee platforms such as Robinhood. Ironically, amongst the ranks of WSB are the likes of bitcoin multi-millionaires (billionaires?). The second is that cryptocurrency magnates or not, WSB is in essence a community of get-rich-quick gamblers, opportunistic day traders, anarchists with a bent for systemic change, or any combination of those labels… there’s a cohort amongst WSB who will happily risk their money to ‘stick it to the man’ and that seems to be a meaningful part of what has happened here. To be clear, I say all of these things, in this case, in the most endearing ways possible. It’s one of my most enjoyed communities online, if for no other reason than the memes.
To the surprise of many, that community - soon joined by vast volumes of gamers and retail investors around the world experiencing FOMO - got some wins on the board. This ‘short-squeeze’ on hedge funds has been estimated to cost them as much as $15 billion. Melvin Capital admitted defeat, closing their positions, accepting huge losses, and required a $2.5 billion bailout from Citadel Investment Group to stay afloat.
Adding fuel to fire, Robinhood then halted the ability for the community to continue to keep buying GameStop, suppressing the price growth and single handedly being a catalyst for killing this trading momentum. Unlikely to be mere coincidence, Robinhood takes money from Citadel to execute their own order flow, and Citadel is an owner of Melvin capital. Class action lawsuits against Robinhood have already been filed.
As right as these hedge funds might have ended up being that the value of GameStop was going to fall, they don’t get to decide. The fact that traders had their ability to participate in the purchase of GameStop in the other direction halted should be cause for serious concern.
What happens next?
As pointed out by the brilliant Matt Levine in his Bloomberg newsletter, Money Stuff, there are a few ways this ends for people who have put money into it. First, bulls suddenly believe GameStop can become an industry behemoth, justifying the meteoric rise, maintaining this new valuation. An alternative, perhaps hedge funds everywhere are sent bankrupt, the entire market is a meme, and capitalism is changed forever. Another is that funds now assist in buying - thus continuing the price pump - to cover losses on their shorts, yet this can’t continue forever and new bets against GameStop’s price continuing to rise are surely happening already.
Among other ends, the most plausible is the one I’ve been warning fellow gamers and retail investors of: that the price is on the verge of collapse; people who got on the train early are ready to cash out of a business they don’t really believe in and a stock price they know can’t be maintained. Chanting “HODL” only works for so long, at some point every holder wants to realise their gains.
The more interesting questions about what happens next arise when considering the implications for markets in much broader terms. The unprecedented scale and exposure of this event is turning out to be quite profound. This has rattled confidence in the market, questioned the underlying integrity of it, and - if we’re really lucky - will change investment behaviour for the better.
Do you remember how financial giants have taken great risks and created fragility events for entire economies, sending countries into recessions? Do you remember 2008, when the poor suffered and the wealthy were bailed out? Now, retail investors have taken great risks and created a fragility event for the wealthy. The wealthy are not pleased. Some are calling for the rules to be changed to prevent it from happening again. Crystalising at the core of this conversation are themes about what is fair and how free our free market really is, should be, or might not be. This entire ordeal is a better lesson in financial literacy than almost anyone ever got during their schooling.
A debate about investment ethics and market mechanics is now being voiced on a stage never so large and never so public. It is being paid attention to by more people than have ever had an interest in the stock market before. Importantly, by young people. The importance of this debate, and the outcomes that arise from it, for the benefit of personal wealth generation and the shaping of our future economies, cannot be overstated.