Should investors worry about GameStop?
Stephen Tuttle

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.

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