Wednesday, January 27, 2021

This Week's Message: Too Much of a Good Thing -- And -- Explaining GameStop

I recall 1999 like it was yesterday... Experiences that engender the most visceral sensations tend to remain prominent in one's psyche.

15 years into my career at the time, while I had the good fortune of managing money through the '87 crash, and the multiple hiccups -- and, not to mention, one major bear market in bonds ('94) -- leading up to the near equity bear market in '98, I yet had no personal experience to compare to what was to come over the next 3 years. 

Nasdaq Comp 1/1/2000 - 3/9/2003:

Fortunately, I had spent enough long hours studying the dynamics around the 73/74 episode, the Depression-Era phenomenon, and other protracted negative periods to know that, indeed, bear markets can not only come swiftly, but they can hang around for extended periods of time as well.

So, yes, to the chagrin of a handful of clients (the rest happily left it up to us, or at least didn't speak out in opposition), I was cutting our tech exposure notably as 1999 came to a close. Not, mind you, because I knew what was to come (I of course didn't), but simply because the outsized, and outlandish, gains pushed us to a notably overweight position in the sector -- and, yes, my study of history strongly suggested that too much of a good thing was... well, too much of a good thing.

Of course, if I had to do it all over again, knowing what I know now, I'd have cut tech to the bone...


You may have noticed in a headline here and there that an unlikely suspect, GameStop, has seen quite the run in its stock price of late.

Yes, that's the brick and mortar video game retailer... In today's world, perhaps the last place anyone might think to invest would be in such a company. Nevertheless, if you had bought a share on the first trading day of this year you'd have paid less than $20 for it. As I type it's trading at $351.57.

Yes, no kidding, a company whose business model is, to put it mildly, suspect, a company whose shares were shorted to the tune of over 100% (extreme bets that it was going down big [from only $20, mind you), is trading like it's got some new green technology that's about to save planet Earth!

So what gives? Well, it's virtually the same thing that gave back in 1999.

I recall a relatively new client at the time who wandered upon a chatroom where everyday folk talked dotcom stocks. As the number of chatters grew something very interesting began to happen. The stocks they chatted about began to see their share prices rise, in many cases exponentially!

My client had a 9-to-5 job, but was able to sneakily trade her E-trade account while she was on the clock. 

Her returns were utterly astounding! She reported to me it seemed like everyday about the stocks she was buying; the stocks her chatmates were touting... She would always ask my opinion, and, as you might imagine, it didn't take long for yours truly to lose all credibility, and eventually to lose her as a client to boot. 

Of course we parted on the friendliest of terms, as, as you might imagine, it was a split that we both felt very good about...

Note that above I said "virtually" in terms of today's explanation for the rise of a GameStop, versus the rise of, say, an Etoys back in '99. 

One difference being that GameStop is anything but a company that's gaming new-edge technology, while Etoys was all about newly-embraced (at the time) online commerce.

What GameStop does have in common with the dotcom darlings of 1999 is that it's indeed a chatroom favorite.

So, now the obvious question: What about that could possibly justify a 1,600% return in less than a month?

Well, if you read the Reddit chatroom they call "Wall Street Bets", it's war!

The self-proclaimed little guy with a Robin Hood account and a 20-minute options trading video under his belt -- who, ironically, worships the richest man on Earth (one E. Musk) -- has vowed to take out the billionaire hedgefunders who are out to take out the market's weakest players by shorting their stocks.

Yep, we're talking one of the most epic short-squeezes of all time! 

Recall -- as we've explained previously -- that when one is short a stock, one has borrowed its shares from someone else through his/her broker. One sells said borrowed shares, expecting them to drop significantly, at which point one buys them back and returns them to their original owner -- pocketing the difference in price sold vs price paid for the effort.

Now, if one's wrong, and the price instead rises, one can lose all one's got. As, remember, he/she eventually has to purchase and then return the borrowed shares. And, as numbers can rise to infinity, in a rising market one can end up paying exponentially more than one sold the borrowed shares for. 

Hence, the term "short squeeze." The (Robin) hoodies, having located the stocks most shorted by those fatcat hedge funds, take great pleasure in buying them en masse, forcing up their prices, and, thus, forcing out the shorts, whose panicky buying to close their positions forces the price up even further!

One added wrinkle - options! 

The volume of small call options contracts traded of late has been off the proverbial chart, besting the, you guessed it, late-'90s record. 

Now, think in terms of the dealers who sold those small call contracts and collected their premiums for doing so. They're the counterparties, and they're the ones left holding the bag -- making good on -- on those incredible gains the buyers are realizing. 

Of course those dealers, no more than can the short-sellers, can't afford such drubbings. So what do they do? They hedge... How do they hedge? They buy the shares themselves... And what does that buying do? It puts additional upward pressure on the price!

Note: I'm listening to Fed Chair Powell field question as I type this note... First question from the audience was, ironically, about GameStop's price action of late. His answer, "I have no comment."

So why would a market reporter ask the Fed Chair about GameStop, of all companies, seeing its share price go literally parabolic? Well, clearly, because it speaks to the bubble we're living in and the financial conditions -- literally created by the Fed -- necessary to create such a phenomenon...

Next question, from CNBC's Steve Liesman: "There's a range of assets that I know you do watch, but, from bitcoin, to corporate bonds, to the stock market in general, to some of these more specific meteoric rises in stocks like Gamestop, how do you address the concern that super-easy monetary policy -- asset purchases and zero interest rates -- are potentially fueling a bubble that could cause economic harm should it burst?"

The chairman proceeded to pull the now oft-invoked political cover of COVID to justify bailing out failed institutions (failing before COVID, btw) and bubbling up markets while claiming that they're doing it to protect the everyday citizen. 

Well, the fact that the much maligned inequality of the nation has risen like a bitcoin over the past year... well, hmm... let me just say that it was a real struggle (painful) to watch him struggle with that question...

So, the point of this week's message? Equities are unequivocally in a bubble -- and, alas, bubbles can persist for years... 

Thus, I'm definitely not calling a top, I'm just saying this is what toppy conditions smell like; I've smelled them before...

What a year! RCA, for example, rose 395%, DD gained 72%, MW grew by 276%, and those were just 3 of many! 

And, no, while I might be (were I referencing other companies), I'm not referring to last year... 

RCA was Radio, DD was/is Dupont and MW was Montgomery Ward; the year was 1928. 

Of course you know what happened in 1929!  

SP500 1/1/1929 - 4/1/1942:

Here's from JK Galbraith's must-read accounting titled The Great Crash 1929emphasis mine...

"Clearly the Federal Reserve was less interested in checking speculation than in detaching itself from responsibility for the speculation that was going on. And it will be observed that some anonymous draftsman achieved a wording which indicated that not the present level but only a further growth in speculation would be viewed with alarm. Yet in the then state of nervousness even these almost incredibly feeble words caused a sharp setback.

The nervousness of the market and the unsuspected moral authority of the equally nervous men of the Federal Reserve was even better illustrated in March.

As the new month approached, Mr. Coolidge made his blithe observation about stocks being cheap and the country being sound. The market surged up in what the papers dubbed “The Inaugural Market,” and on March 4, his attitude toward speculators still unknown, Mr. Hoover took over. The market for the next couple of weeks remained strong."

To follow was a stretch where the Federal Reserve Board, knowing that a dangerous bubble had formed, feeling that they probably should intervene and try to let some air out -- yet fearing that it was far too late and (per the above quote) that they'd capture all of the blame should such an effort lead to an all out bursting -- fell silent.

A silence that, by itself, drove insane the market actors who -- like today's -- thought that the Fed had their backs:

"Although, or rather because, Washington was still silent, people began to sell." 

"On the next day, Tuesday, March 26, everything was much worse. The Federal Reserve Board was still maintaining its by now demoralizing silence." 

"A wave of fear swept the market. More people decided to sell, and they sold in astonishing volume." 

"Prices seemed to drop vertically." 

"Thousands of speculators, in whose previous experience the market had always risen, now saw for the first time the seamy side of their new way of life."
So, am I at all suggesting that we're about to repeat the 1929, or, say, the 1999 experience? 

Well, no, I'm simply suggesting that we are indeed living in yet another stock market bubble. 

Whether or not it bursts all at once and leads to a protracted bear market, as similar past setups have, or the Fed and the Treasury can keep it floating indefinitely, or somehow bring it slowly down to earth, remains to be seen.

Bottom line, the risk is there... as are the opportunities inherent in a setup where the Fed will (has to) effort mightily to keep interest rates, and the dollar, down, while the government will ultimately be spending like mad on infrastructure...

So stay tuned.... and stay hedged!

Thanks for reading!

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