Should Investors Worry About GameStop?

The last weeks of January saw a dramatic surge in the prices of several heavily shorted stocks as retail investors piled into names like GameStop and AMC Entertainment. The story has dominated headlines recently, leading many investors to wonder how this might impact their investments.

What’s our view?

The crazy market action in Gamestop and other smaller stocks recently does not change our outlook. While the short-covering rally is no doubt exciting and interesting, we believe it is only a sideshow. We don’t think there will be a big, lasting impact for long-term investors.

We believe this remarkable rise is for technical reasons, not supported by fundamental improvements in the underlying businesses, so we’re not interested in owning these names.

We continue to focus on the fundamentals. We believe the positive macro environment, improving fundamentals, progress with covid-19, and the strength of the US consumer will support markets. The re-opening of the economy deserves far more attention & will have more impact on returns to the broad market than a handful of speculative, small-cap stock situations.

What happened?

Some stocks with high levels of short interest have surged recently. Before the recent rise, these stocks, like GameStop, had been struggling. Some hedge funds made bets that these stocks would decline further. In such trades, called “short sales”, investors borrow a share and sell it in hope of buying it back later at a lower price, and profiting from the difference.

The stock began rising sharply last month with support from social media influenced buying. This prompted short sellers to buy shares as well to cover their bets. That accelerated the momentum even more, creating even more buying.

Where do we go from here?

There’s a lot of information we still don’t know about who was involved, what they did, and why they did it. We don’t know how regulators will respond. The SEC has said it is “monitoring” the situation, and members of Congress said there will be hearings.

We expect regulators to impose new rules around retail trading. Trading options and use of margin could be curtailed. Brokers may need to make changes too. Their apps and websites have to improve capacity to keep up with the surge in retail treading. Hedge funds will also have to adjust how they manage risk and deal with concentration. We also expect more interest in new data sources, like message boards and credit card receipts.

The democratization of markets is getting a lot of attention. It’s not a bad thing that more retail investors to own stocks. Unfortunately, some are ill-prepared to manage risk & make informed decisions with their finances. We suspect this will end badly for those trying to get rich quickly.

Final Thoughts

The events of the past few weeks have highlighted that in the near-term, stock prices can become unhinged from their fundamentals. It is uncommon, but not unheard of.

Famous value investor, Ben Graham, described the stock market in the short run as like a voting machine, favoring popular firms. In the long term, markets are like a weighing machine, assessing the substance of a company.

We believe the current risks of the GameStop saga seem contained to small areas of the capital markets. The negative impact is primarily on hedge funds and short sellers. We will continue to monitor the situation.

Overall, we maintain our optimistic outlook for the economy and markets. We are encouraged by signs of recovery and see more upside potential for investors in the years ahead.

Steve Tuttle

Partner, Chief Investment Strategist, Chief Compliance Officer

IMPORTANT DISCLOSURE

Past performance may not be indicative of future results. Different types of investments and investment strategies involve varying degrees of risk, and there can be no assurance that their future performance will be profitable, equal any corresponding indicated historical performance level(s), be suitable for your portfolio or individual situation, or prove successful. The statements made in this newsletter are, to the best of our ability and knowledge, accurate as of the date they were originally made. But due to various factors, including changing market conditions and/or applicable laws, the content may in the future no longer be reflective of current opinions or positions. Any forward-looking statements, information and opinions including descriptions of anticipated market changes and expectations of future activity contained in this newsletter are based upon reasonable estimates and assumptions. However, they are inherently uncertain and actual events or results may differ materially from those reflected in the newsletter. Nothing in this newsletter serves as the receipt of, or as a substitute for, personalized investment advice. Please remember to contact Signet Financial Management, LLC, if there are any changes in your personal or financial situation or investment objectives for the purpose of reviewing our previous recommendations and/or services. No portion of the newsletter content should be construed as legal, tax, or accounting advice. A copy of Signet Financial Management, LLC’s current written disclosure statements discussing our advisory services, fees, investment advisory personnel and operations are available upon request.

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