Hi all,

Did you hear GameStop went viral?

Here’s a quick guide to the market frenzy you’re seeing in the headlines.

Long email ahead. (Buckle up, it’s a little complicated.)

What is GameStop and why does everyone care?

GameStop is a brick-and-mortar video game chain that hit hard times in the pandemic. Like many distressed companies, it was targeted by short sellers betting that the stock’s price would go down.

Basically, short sellers do the opposite of most investors. They try to make money when a stock’s price falls. They borrow shares from their brokerage for a fee, immediately sell them, and plan to buy them back later at a lower price when the price falls. Shorting is a strategy used by certain types of hedge funds.

What’s a short squeeze?

Shorting stocks is risky since any positive news or interest in a company can drive the stock’s price up. When short sellers bet wrong and a stock’s price rises, they can be forced to buy shares at higher prices to cover their losses (or pony up more collateral). 

A squeeze happens when short sellers scramble to buy shares to cover their positions when the stock price is rising. The more investors who buy and hold those shares, the harder it is for short sellers to find shares to buy (exposing them to potentially huge losses).

With me so far?

Where does Reddit come in?

After it became clear that short sellers were betting on GameStop’s demise, the videogame retailer became the focus of amateur traders on the popular WallStreetBets forum on Reddit, a popular community of chatrooms and forums.

By banding together and coordinating buying activity, these small-time traders boosted the stock’s price far above what the company’s financial fundamentals support, putting pressure on the hedge funds betting the other way.

The stock went viral.

Why?

Social media chatter + free trading apps like Robinhood + bull market + new investors with time on their hands = FRENZY

Is it illegal? That’s a stretch. These armchair traders are egging each other into speculative bets, but I don’t think it rises to the level of illegal market manipulation. However, regulators might feel differently.

Is it bad for markets? The battle between gleeful amateurs pushing prices up and hedge funds scrambling to force prices down has led to some of the highest volume trading days on record and cost short sellers billions.

Is this David vs. Goliath?

I don’t think the GameStop bubble is just about greed or boredom or euphoria. I see a powerful narrative at play.

I think a lot of these small traders are angry at the perception that All-Powerful Wall Street is pulling strings and using their connections to hurt mom-and-pop investors. They see this as an opportunity to stick it to the big-money pros by using their own strategies against them.

It’s new school vs. old school. Rebels vs. the Empire. Bueller vs. Principal Rooney. Reddit vs. CNBC.

So, should I be investing in GameStop?

No. GameStop’s stock is massively inflated and trading has been halted multiple times because of its meteoric rise. At this point, it looks like folks are piling in just to say they were there.

When the bubble bursts, it’ll be a rush to sell and many GameStop holders will end up losing most of their investment.

(It might already be happening by the time you read this.)

We’ve seen frenzies like this many times before. Tulip mania in the 1630s, the Nifty Fifty in the 1970s, the dot-coms in the 1990s, Bitcoin’s multiple bubbles over the last decade, etc. We’ll see more in the future.

Why are people angry at Robinhood?

Amidst the buying frenzy, Robinhood and other popular brokerage platforms suddenly restricted trading on several red-hot stocks, including GameStop.

Protests erupted from investors, many market pros (not the short sellers, obviously), lawmakers and more. 

Did Robinhood halt trading to appease big investors at the expense of small investors? Did they do it to protect markets from manipulation and liquidity problems?

Personally, I think Robinhood could not handle the volume of trade orders coming in and stopped trading because they could not ensure the integrity of the orders. 

I dislike the idea that a broker can just shut down trading in a security. I think it opens the door to situations where platforms prioritize one investor over another and that’s a massive conflict of interest.

I’m frustrated on behalf of everyone else affected by brokerage outages and difficulty trading.

But frankly, it’s pretty wild that a bunch of regular folks with small trading accounts can bring massive institutional investors to their knees.

What are the implications of this frenzy?

There’s no predicting the future, obviously, but I think a few things are likely. Most bubbles end naturally when the euphoria turns to panic, folks start selling, and the price crashes.

However, it’s also possible that regulators will step in if they think there’s risk to markets (or they see too many investors getting hurt). 

Hopefully, regulators do not interfere. They would inevitably do more harm than good. Investors be they small or big, should NOT expect regulators to bail them out simply because they made stupid decisions.

All investors should assume the risks and reap the rewards of their own choices. 

I think this ride’s going to end in tears for many folks caught up in it. But I’m not sure who will be crying hardest. 

I think markets will see some wild swings and pull back from their frothy highs, at some point this year. 

But, I think we’ll be left with some pressing questions once the dust settles.

Will social media traders continue to drive big market moves?

Do platforms have the right to arbitrarily decide customers can’t trade? 

Are coordinated moves by small investors a danger to markets?

Should regulators be watching hedge funds more closely?

This is an evolving situation so I’m keeping a close eye on markets to see what might happen next.

Questions? Thoughts? Please hit “reply” and let me know.

On a lighter note, could we have a more interesting matchup in the Superbowl? 

Have a wonderul week!!

No more meme stonks, please.

Sincerely, 

Wyatt Swartz

Financial Adviser, RIA
W. Swartz & Co.
(636) 667-5209 | www.wswartz.com

Over the next 12 – 14 months stock markets will act as weighing machines between the positive and negative forces that exist in the world. Ultimately, the direction and magnitude of movement for stock markets will be determined by the balancing of these positive and negative forces.

What we think:

Widespread vaccination and the subsequent “reopening” of economies should allow economic growth to surge in the second half of 2021. 

The combination of positive sentiment and high valuations in US stocks will hold back returns, because much of the good news is already baked into current prices.

More predictable trade policy from the US will lead to stronger international growth and a weakening of the US dollar in relative terms.

With democrats holding a small majority control of Congress it is likely we see more stimulative fiscal policy. This furthers the case for a weakening dollar and international stocks.

It is likely that we see a steepening of the yield curve over the next year. The Fed seems poised to maintain very low short-term rates until “maximum employment” is reached. A widening spread between short-term & long-term rates would be a positive for financial stocks.

Earnings should rebound in 2021. However, US stocks will likely be constrained by valuations that are historically high. This bodes well for international and emerging market stocks which have much lower valuations relative to US stocks.

What does it all mean:

While I believe stocks are in the early stage of the next great bull market cycle. High valuations and overly positive sentiment create an environment perfect for market corrections and a temporarily sideways market. Earnings need to catch up with prices.

Investors should use corrections as an opportunity to invest idle cash, and/or rebalance their portfolio heavier to stocks.

Investors should overweight to international & emerging market stocks relative US, because of attractive relative valuations, and a weakening dollar. Investors should overweight cyclical, and small cap stocks which will see bigger bumps in the early part of the recovery. 

With the presidential election still too close to call, we wait. 

While we wait, let’s think about what we do know, and what we expect given the current information. 

What we know: 

ONE: Policy has a greater impact on markets and economies than politics does. 

TWO: Republicans will probably maintain control of the Senate. This means there will most likely be divided government no mattter who ultimately wins the presidency. 

What we expect:

An extrememly narrow Biden electoral win. 

However in either scenario, a Trump or Biden win, there will be divided government. 

It is very unlikely to see any major legislation enacted over the next two years. 

Obamacare and the Tax Cuts & Jobs Act were both passed when one party held control of Congress and the Presidency. 

No other major legislation has been passed in the last 12 years and that is unlikely to change in the next two years. 

Both candidates will try to pass fiscal stimulus. 

Both candidates will continue to increase the national deficit and debt. This could prove inflationary in the longer-term. 

Both candidates might have to deal with the fallout of Obamacare should the Supreme Court deem it unconstitutional. 

The President has the most power dealing with foreign policy, and that is where we will see the biggest changes with a Biden victory. 

Sincerely,

Wyatt Swartz

Financial Adviser, RIA
W. Swartz & Co.
(636) 667-5209 | www.wswartz.com

11/4/2020