God, who delivered me from the teeth of a lion and claws of the bear, will deliver me from this Philistine. 1 Samuel 17:37
Everyone likes an underdog story, particularly where someone has no chance at succeeding. Lots of movie and novel plots have been written using this simple storyline. One of the first such story comes from the Bible where the outmanned Israelites face off against the Philistines.
The Philistine “champion” was named Goliath. He was huge, standing nearly 10 feet tall. His armaments – a spear weighing 15 pounds and body armor weighing 126 pounds – were intimidating. He was THE man, and he challenged the Israelites to “Give me a man” to fight. He did this for three days. The Israelites cowered in fear.
Enter David, a shepherd, who left his flocks to visit his brothers in the Israelite army. While there, David took up the challenge but refused body armor. He was armed with a shepherd’s staff, a sling and 5 smooth stones. The battle didn’t last long – just one stone to Goliath’s head and he was done.
We have a modern day David vs. Goliath story that came up in the investing world. It has surprised many. The Goliath in this story is Hedge Funds that have used the tactic of shorting stocks – literally betting that the company’s stock value will go down. These are big entities worth billions of dollars and their investors are limited to the ultra-rich.
A little background first. In the investing world, taking a short position in a stock is not uncommon. I won’t describe all the means to do that, but for the normal publicly traded stock, it is not unusual to have a “short position” of 1 to 3% of the total shares outstanding. These are investors who believe the price of the stock will go down, not up.
In a ”short transaction”, an investor “sells” stock he doesn’t own by “borrowing” it from institutions who lend it. The investor’s plan is to buy back the stock at a lower price, replace his loaned stock, and take a profit.
Investors who use shorting are sophisticated. But what happens if the stock goes up, not down? Good question. It’s called a “short squeeze”. In order to limit losses, the short interest investor has to buy back the stock at higher prices, which, in turn forces the price up more.
When the pandemic hit, people had time on their hands and quickly figured out that investing is fun, particularly in a market that is going up. Robinhood became very popular. Social media also brought another feature – chat rooms and other forums where small retail investors band together and share thoughts about investing.
Forums appeared on Facebook and Reddit, including WallStreetBets, which quickly grew to a million users. Founded in 2012, the site morphed into a powerful force of amateur investors. The forum realized hedge funds were predators, often making outsized bets that a certain company will fail.
One such company was GameStop, a struggling retail store that sold video games. Hedge funds raised the short interest in the company to a staggering 140% of the outstanding shares. Then something happened. A lot of amateur Davids showed up with their sling and started buying the stock, sending the price up by 500%.
It was a massive-short-squeeze. You could say the hedge funds got caught with their shorts down. One estimate of the damage was around $19 billion in losses just on GameStop alone. Two hedge funds almost collapsed because of the losses. Small amateur investors took on the hedge funds.
Not sure where this story will end. Everyone on all sides is pouncing on this – some calling for more regulation (not less). Under pressure, Robinhood stopped the ability to buy GameStop in the middle of the day – you could only sell it. Lawsuits will abound.
Many of these amateur investors are millennials and Gen Z and their motivations for being involved are varied. Some want to pay off debt, others to make a statement, and still others are in it for the lulz.
This story is fascinating to me on many levels. This is not about investing, by the way. It is a form of speculation. None of these amateurs looked at the financials on GameStop to see whether it is a good company. Eventually, GameStop will return to normal trading levels. Some small investors will get hurt.
It is also a demonstration of the power of social media and the internet to change institutions in ways never thought possible. The latest story shows the power of people to band together to cause something to happen. I picture in my mind an image of a large school of small fish in the ocean that collectively can turn on a dime as if they were choreographed.
The next generation is using “the tools they have to upend the status quo” according to Tim Elmore. They are leveraging the power of numbers against the power of status which they believe needs a day of reckoning. They now have a voice and feel empowered to use it and possibly in things other than stonks.
The challenge is that the next generation may overdo the movement of the crowd. They haven’t learned that the market has its own “gravity”, and the price of a stock will return to a normal after being artificially increased through speculation.
MENTOR TAKEAWAY: If your mentee is following the GameStop pack, be sure to caution him to be careful with wagering on the stock market in big amounts which results in big risks. Risk and reward go hand in hand.
FURTHER READING: WallStreetBets Founder Reckons with Legacy – WSJ
A Long Cynical Post – Taibbi (R rated language)
WORSHIP: You Make Me Brave – Amanda Cook
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