When will the Game Stop?

By: Andrew J. Willms

President and CEO of The Milwaukee Company


Jake Willms, Quantitative Analyst

There’s a new game being played on Wall Street these days. Surprisingly, the players are individual investors and it’s the Wall Street establishment that is being played.

The game, which some are calling “Get Shorty”, resembles a real-life version of the video game mode known as “Battle Royale”, where the objective is to kill off all of your opponents and be the sole survivor. In Wall Street’s version of Get Shorty, the battle is between hedge fund managers who have sold the stock of struggling companies short, and individual, oftentimes novice, investors who collectively buy large amounts of the shorted stock, thereby pushing prices higher, and putting the “squeeze” on the traders.

(By way of background, a short sale is a transaction where a trader borrows stock and then immediately sells it, hoping he or she can repurchase those shares later at a lower price, return them to the lender, and pocket the difference. Short sellers are betting on the stock price going down. But, if the price unexpectedly goes up, the short seller will have to repurchase the shares he or she needs to repay the loan at a higher price, thereby resulting in a loss.

Wikipedia describes a short squeeze as a “rapid increase in the price of a stock owing primarily to technical factors in the market [in this case increased demand resulting from individual investors gobbling up massive numbers of shares], rather than underlying fundamentals. A short squeeze can occur when there is a lack of supply and an excess of demand for the stock due to short sellers covering their positions.”)

The ongoing GameStop short squeeze started last August, when Keith Gill, a 34-year-old financial advisor and Chartered Financial Analyst (CFA) from Massachusetts, began posting videos on his on his “Roaring Kitty” YouTube channel, suggesting GameStop was undervalued. He purchased $53,000 worth of call options in July of 2019 and saw his position rise sharply to be worth over $40 million by the end of January 2021. His daily update posts in the r/wallstreetbets, a reddit community of stock traders and investors alike, sounded a drumbeat for buying GameStop stock and helped initiate the short squeeze.

On January 11, it was announced that activist investor and Chewy[1] co-founder Ryan Cohen was joining the board of GameStop, a struggling brick and mortar video game, consumer electronics, and gaming retailer. The stock jumped on the announcement, on hopes that Cohen would breathe new life into the struggling company. Fuel was added to the fire on July 22, when word got out that over 140% of the GameStop stock outstanding was sold short. Redditors recognized the resulting opportunity, buying the stock with a commitment to hold until the short positions were closed.

Before long, a new “Occupy Wall Street” movement of sorts took hold on social media, not by social justice protestors, but rather by Robinhood investors, who rallied around holding GameStop and refusing to sell in an effort to stick it to hedge funds who sold the stock short.

Not wanting to miss out on the next opportunity, investors began to turn their attention to other highly shorted stocks in hopes of repeating Mr. Gill’s audacious feat. Soon, share prices of other depressed companies with heavily shorted stocks began to soar, including those of AMC Entertainment, Blackberry, Bed Bath and Beyond, and Milwaukee’s Koss Corp. The “movement” has now grown to encompass dozens more companies, raising concerns that it could potentially destabilize the overall market.

The hedge fund managers had hopes of regaining the upper hand on Thursday, as Robinhood, Interactive Brokers, E*Trade and began curbing trading of GameStop and other stocks popular with the financial flash mob, supposedly due to increased volatility and reported increasing deposit requirements for clearinghouses. Robinhood’s move led to the price of GameStop stock falling by 44%, but the stock recovered Friday after trading was opened up again.

Hedge fund titans have lost an estimated 20 billion this month to the so-called amateurs. Some funds are teetering on collapse. But the drama is far from over, and some market followers have suggested that the novice investors, who have been trouncing the seasoned pros so far, will end up being the ones who ultimately get trounced.

There is little doubt that investors who are still at the Get Shorty party when the music stops will get burned. And no one can say for sure how long the party will last. But in the interim, many savvy investors will book sizable profits as a result of the short squeeze. Case in point: Mr. Gill’s brokerage account statement showed a cash balance of over $13 million, in addition to the tens of millions of dollars of GameStop stock he still owns.

When the party does come to an end (as it inevitably will), I suspect the media will focus on newbie market participants who lost a sizeable share of their hard-earned savings, and politicians will call for more regulations to protect individual investors from themselves. Then again, as Oprah once said, “Failure is a great teacher, and, if you are open to it, every mistake has a lesson to offer.”

It seems to me that the increasing role of technology has given younger investors an edge in today’s market. Take my son Jake, who is a quantitative analyst for The Milwaukee Company, with a Master’s Degree in quantitative finance. He’s adept at writing the computer code that we use to evaluate changes to our existing strategies and test new candidates. This code can run simulations in an effort to forecast how an investment strategy will do under tens of thousands of alternate scenarios. Try doing that on the Texas Instruments Business Analyst calculator I used in college!

A recent blog post you can find here mentions a book Michael Lewis wrote following the bursting of the 1990’s Dotcom bubble entitled “Next: The Future Just Happened”. In it. Lewis argues that changes in the way markets function have given young investors an edge:

But it does seem to me that when capitalism encourages ever more rapid change, children enjoy one big advantage over adults: they haven’t decided who they are. They haven’t sunk a lot of psychological capital into a particular self. When a technology comes along that rewards people who are willing to chuck overboard their old selves for new ones—and it isn’t just the Internet that does this; biotechnology offers many promising self-altering possibilities—the people who aren’t much invested in their old selves have an edge.

A child still has time to save himself. To a child, being on the wrong end of the trend is not a sign that it’s time to dig in and defend the old position; it’s a signal to cut and run. Progress depends on these small acts of treason.

Although Mr. Lewis’ book was published over 20 years ago, to my ears his observations ring just as true today as they did back then.

Thank you for reading.

Andrew J. Willms

President and CEO, The Milwaukee Company

[1] Chewy is the online pet food company that was acquired by PetSmart in 2017 for $3.35 billion.


This Week’s Market Commentator’s Podcast.

In this week’s podcast, I talk with Mike Willms, The Milwaukee Company’s Director of Trading and Market Research, regarding whether inflation or reflation are more likely, the so-called “reflation trade” and the impact reflationary fiscal and monetary policies that have been proposed by the Biden administration might have on the markets. You can listen to the podcast here.

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