The drama of the GameStop stock bubble has provided an interesting study in herd behavior, and a demonstration of one reason that there will always be both rich and poor people.
Some background: GameStop is a national brick-and-mortar video game retailer struggling in competition with online sellers, whose stock was trading in a relatively low price range. Some hedge funds had purchased massive short positions in the company's stock. Simplified, a "short" is a gamble that pays off if the price of the particular stock falls within a specific period. Essentially, the short trader "borrows" the stock for a specified period, and sells it at the current price. When due, they must purchase replacement shares to return. If the stock price has sunk, they gain by paying a lower price for the replacement shares. But if the stock has risen, they must buy it at the higher price, thus losing the additional amount paid. The higher the stock goes, the more the short-trader stands to lose. In summary, the hedge funds had bet that the price of GameStop would tank. Instead, it soared and they took a big-time beating from having to replace it at a higher price.
It has been a real roller-coaster ride. Between September 2020, and mid-January 2021, GameStop was trading in the relatively stable range of $10 to $20 per share. It then suddenly soared as high as $483 per share, before collapsing to $40 by Feb. 19. The price had since partially recovered to $158 as of April 21.
Unlike the typical situation with wild fluctuations in a stock's price, the
business and prospects of GameStop remained fairly stable during this wild ride, and the wild price fluctuation had little connection to the intrinsic value of the company and its prospects. In theory, a stock's price should be the net value of the company's assets, divided by the number of outstanding shares, and perhaps adjusted by its prospects.
Instead, this boom was driven by social media as a sort of populist crusade against the hedge funds and Wall Street. Posters on the WallStreetBets forum on Reddit tempted followers into buying GameStop as a way to punish the hedge funds and Wall Street, and to make some money in the process. It worked, at least initially. The hedge funds lost billions, and the early investors who sold before the collapse made a lot of money. "Roaring Kitty," the screen name of the chief Reddit tempter, made around $20 million.
It is hard to sympathize with the short-trading hedge funds. As sort of financial vultures, these corporate carrion-eaters learned that sometimes your planned dinner manages to crawl away.
The GameStop mania was a tout-driven Ponzi scheme, in which the early investors made money off of the latecomers, as well as from the hedge funds. Some losing investors bought on margin (with borrowed money), and must now repay the loan. Some of the losers are gamers who are just now realizing that investing does not have a "reset" button.
What I find amazing are the continuing exhortations on Reddit to buy and to hold the shares. In their forum, shareholders are pledging to each other to "hold the line," hoping that their "belief" will drive the price back up and keep the party going. Sort of like playing financial chicken. Most of the GameStop short-traders are gone.
Of course, investor herd mania is nothing new, as was demonstrated by the famous "Tulip Bubble" in the Netherlands during the 1600s. There, investors were paying up to six times the average annual salary for a single tulip bulb before the market crashed.
Most people jumping into a bubble lose money. Why act so recklessly? Some are impulsive gamblers, like those who invest their entire savings in lottery tickets when the prize grows to a newsworthy amount. Others have unrealistic notions of their own financial savvy, certain that they possess the instincts to spot and time a good investment.
But many are just following the herd. Seeing everyone else doing it, they are afflicted with FOMO—fear of missing out. When, as a child, a parent rhetorically asked them, "If everyone else were jumping off of a cliff, would you?" they answered "of course I would!" To them, the herd's wisdom will only be questioned in retrospect.
Which brings me to my theory of "Economic Darwinism." This holds that in the financial world, there are both predators and prey. Some people habitually do such dumb and impulsive things with their money that they doom themselves to a lifetime of financial struggle. The more cunning are posed to profit off of them, and will end up either rich or in jail. A third group avoids any attempt at quick, easy money and tends to remain financially intact.
Most of those who risk their savings chasing the latest financial big, new thing captivating social media are facing the natural selection of the financial world. Δ
John Donegan is a retired attorney in Pismo Beach who is awfully tight with a buck, and is too cautious to put the little darlings in peril. Send a response for publication to.