The Financial Philosopher

A Simple Explanation of the Gamestop Stock Story (Plus Key Lessons)

"The markets can remain irrational longer than you can remain solvent." ~ John Maynard Keynes

Why is everyone talking about GameStop? Perhaps you've heard the story but it can get complicated, depending upon who is explaining it. Through January 27, 2021, GameStop (GME) stock had climbed a staggering 8,000% in one year. That same day marked GME's biggest one-day increase, as the price jumped 135%. How can a stock climb so high, so quickly? Here's a simple explanation.

 

Simple Explanation of GameStop Stock Story 

The basic narrative around GameStop stock is that a group of rogue traders decided to buy shares, with the goal of bidding up prices, which would ultimately punish larger institutional traders, collectively referred to as "Wall Street." How can these rogue traders do this? What exactly was their strategy?

The GameStop stock story and how it all works:

• Until mid-2020, GameStop's stock (GME) had been flatlining for several years, as the brick-and-mortar company struggled to survive in an online retail environment, driven by businesses like Amazon (AMZN).
• Renewed interest in video games, brought on by the Covid-19 shut downs, provided a small boost to GME stock in August 2020.
• A more significant boost in the GME stock price came as Ryan Cohen, co-founder of the e-commerce site Chewy, reportedly bought a 9% stake in GME. 
• A sudden surge in the GME stock price came later in 2020, as users of Reddit, a social news and discussion website, encouraged followers to buy shares of GME.
• These rogue traders, many of them smaller traders and first-time investors, using an investment app called RobinHood, had a plan to get revenge against Wall Street, specifically the short sellers.
• Short selling occurs when an investor borrows shares of a stock, sells the stock, and then buys the stock back to return it to the lender. It's basically gambling on stock prices.
• To get this revenge on Wall Street and the short sellers, the rogue traders would buy shares of GME, which would push GME prices higher, thereby forcing what is called a "short squeeze."
• A short squeeze occurs when short sellers are forced to buy shares of stock that they bet against. Short sellers are essentially betting a stock price will go down. If the stock price falls, short sellers profit; if the price goes up, the short sellers are forced buy more shares at higher prices, which means they "lose" and the other investors (long positions) gain because more buying has occurred. 
• The short squeezing resulted in more buying which has created a sort of self-feeding mechanism. Thus, the rogue traders have been successful, to a degree, in short squeezing the larger, more experienced traders. 
• Meanwhile, GameStop is still not a fundamentally sound business, which means the stock price is going to fall, once the "game" is over.
• As of January 28, 2021, RobinHood limited trading activity on GME stock and the price fell 44% on that day.

Key Lessons to Learn from GameStop and Market Bubbles

Irrational behavior, in the form of market crazes and buying frenzies, is nothing new to investing. In fact, the first famous bubble and subsequent burst goes back to the "Tulip Bulb Market Bubble" in the 1600s. Fast forward about 400 years, to the late 1990s, when I first began managing money, there was the technology stock boom, or dot-com bubble. More recently, the digital currency Bitcoin has a similar story. 

Here are some of the things I tell clients with regard to stock buying frenzies and market bubbles:

• Stock prices can get irrationally high, which creates a bubble that always ends up bursting.
• By the time the media is talking about a hot market trend, it's usually too late to get in on it.
• The investors that make the most money from a buying frenzy like GameStop are the ones who get in at the beginning and sell toward the end.
• Timing the market (buying at the bottom and selling at the top) is nearly impossible.
• For example, to get the 8,000% one-year return from GME stock, an investor would have had to buy when GameStop looked like a complete losing bet, then sell the stock at its peak, when it appears to still have unlimited potential.
• Like other stock market bubbles and stock buying frenzies, the GME stock story will end miserably.
• Investing passively in a stock index has historically produced higher returns, over a 10 year period or longer, than the majority of professional money managers.
• Always remember, time in the market generally beats timing the market.

Most importantly, remember that life is not about making money; money is about making a life.

Kent Thune is a philosopher who happens to be a wealth manager and a Certified Financial Planner (TM). Serving clients all around the U.S., Kent is owner of Atlantic Capital Investments, LLC, a registered investment advisory firm located in Hilton Head Island, SC. Kent is also a freelance writer and his works have been published on multiple investing websites, including MarketWatch, Yahoo Finance, Kiplinger.com, InvestorPlace.com, and The Motley Fool. 

In One Word: Why the Market Keeps Going Up (and What Will Make It Fall)

55 million Americans have filed for unemployment benefits, 10% of the workforce remains unemployed, and there is historic civil unrest in our nation. But stocks have jumped 50% since the market's bottom in March. Whether you're all in with stocks or you're 100% cash (or something in between), you're likely wondering two things now: 1) Why does the stock market keep going up and 2) What would make the stock market crash again? 

The answer to both questions can be boiled down to just one word: Vaccine. Here's how and why...

Using the '5 Whys' to Explain Today's Stock Market

Now other questions may come to your mind: You can see how a coronavirus vaccine (or the anticipation of one) can make the stock market go up. But how and why would the vaccine make the market go back down? Wouldn't stock prices just keep climbing after we get an FDA-approved vaccine? Also, aren't the market gains primarily due to fiscal and monetary stimulus? What does the vaccine have to do with this? 

To answer these questions, let's enlist the 5 whys, which is a problem solving method most notably used by Toyota Corporation. The idea behind this philosophical method is that asking "why" just once is not sufficient to find the root cause of a problem. But asking "why?" 5 times can reveal the real answer:

Why the Market Keeps Going Up

1. Why does the stock market keep going up? Trillions of dollars in monetary and fiscal stimulus, along with the belief that this stimulus will continue as long as it is needed.
2. Why the stimulus? The underlying fundamentals of the economy are weak and would be devastating if not for the stimulus.
3. Why is the economy weak? Because of historic unemployment, among multiple related challenges.
4. Why do we have historic unemployment?  The short answer: Covid-19 continues to threaten the economy. The longer answer: Businesses are shutting down or reducing services, due to government mandates to prevent the spread of Covid-19, consumer fear of the virus, and because of uncertainty over the degree of negative economic impact from ongoing government shutdowns and restrictions. 
5. Why does Covid-19 continue to threaten the economy? There's no vaccine.

Why Might the Market Crash Again?

1. Why might the stock market crash again? Traders and short-term investors will believe the best gains have been made and they will begin selling to lock in gains. Thinking that the anticipated crash has arrived, herd-selling would ensue, creating a self-fulfilling prophecy.
2. Why might investors lose confidence? The Federal Reserve and government end their stimulus.
3. Why would the stimulus end? There's no incentive for the Fed and government to continue borrowing and spending.
4. Why would there be no incentive to continue the stimulus? Because the threat of negative impact from Covid-19 would be significantly diminished.
5. Why would the threat of Covid-19 be diminished? Because there's a vaccine.

In summary: The lack of a vaccine is the fundamental reason for continued stimulus; thus, it is the fundamental reason that the stock market keeps going up. Upon the announcement that a vaccine has been approved, especially if this occurs after the presidential election, there would be almost zero expectation for stimulus to continue; thus, the stock market is left without support. All bets are off and the market enters into a downward spiral.

Buy the Rumor, Sell the News?

There's a saying among investors: Don't fight the Fed. In translation, this means that, if the Fed is stimulating the economy, stocks are the place to be. The Federal Reserve has explicitly stated that the "economic recovery will depend significantly on the course of the virus." This is why bad news has consistently been good for stocks. It translates into more stimulus.

But because the Fed has made it clear that they have investors' collective back as long as there's no vaccine, they've made an implicit statement that the market is on its own when the vaccine arrives. When the primary reasoning for the stimulus is removed, the Fed will then remove the proverbial punch bowl and the party is over.

To use another colorful bit of phrasing, traders and other short-term investors may see the coronavirus vaccine as a "buy the rumor, sell the news" type of event. The idea is to ride prices higher, as the rumors of the event continue, although the fundamentals of the economy remain weak. Expecting that the news of the event will herald the short-term peak for stock prices, traders will sell shares to lock in their short-term gains.

Put simply: stocks go up on the rumor of a vaccine; stocks go down on the news of the vaccine.

Bottom Line

While the downside potential for stocks post-coronavirus vaccine may not be immediate, a stock market correction is almost inevitable soon after FDA approval of a vaccine is announced. Post-vaccine, more attention will turn to the fundamentals and many over-priced stocks will be sold off. Put simply, when hope, fantasy, and the political will for stimulus are all removed, investors are faced with the cold hard reality of a weak economy. The uglier that reality looks, the harder stocks will fall. 

But it's great to be a long-term investor! As I stated in my recent post, Rational Investing in an Irrational Market, long-term investors can have their cake and eat it too by remaining allocated to stocks, somewhere between 30% and 70%, with the remainder mostly in cash (keeping in mind that bond prices have almost zero upside potential when the Fed ends stimulus). This tactical asset allocation strategy enables the investor to participate in the upside, then buy more shares on the downside.

Above all: Stay focused on the things in life that are much more important than money.

Kent Thune is a philosopher who happens to be a money manager and a Certified Financial Planner (TM). Kent is owner of Atlantic Capital Investments, LLC, a registered investment advisory firm located in Hilton Head Island, SC, serving clients all around the U.S. Kent is also a freelance writer published on multiple investing and finance websites, including MarketWatch, Yahoo Finance, Kiplinger.com, InvestorPlace.com, The Balance, and The Motley Fool.  

 

 

 

'Sell in May & Go Away' vs 'This Time It's Different'

"Men in the game are blind to what men looking on see clearly." ~ Chinese Proverb

Although stock prices began the month of May on a mixed note, equities ended the month of April 2020 with their biggest month since 1987. Has the investor herd finally begun to price in the harsh realities of an historic recession to come or will investors continue their seemingly irrational buying binge? It appears as if a clash between two classic investment mantras is set: "Sell in May and go away" versus "this time it's different."

Which will prevail? Here are my thoughts on each, plus a third alternative:

Sell in May and Go Away?

The idea of "sell in May and go away" is that the summer months of trading have historically been the worst months for stocks. Based upon the first trading days in May, starting with a decline of 2.8% on S&P 500, stock investors appear to be finally coming to grips with reality and pricing in the fundamentals they are hearing in recent quarterly earnings reports. Might this continue through the month? 

Here's what could make the 'Sell in May' investors right:

• 30 million unemployed and counting: 18% of the labor force is unemployed and the numbers are likely to go up in the short term. For reference, the peak unemployment rate during the Great Depression was 25%. More recently, during the Great Recession of 2007-2009, unemployment peaked at 10%. This recession could come close to depression levels, then remain at "just" extreme recession levels for quite some time. 
• Covid-19 treatment and vaccine uncertainty: Although stock prices jumped in April, partially on the hopes of Chloroquine and Remdesivir as game-changing Covid-19 treatments, the former has mixed results and will not be approved by the FDA for C-19. The latter can only be given intravenously (with an IV) and is reserved for those with extreme symptoms. The bottom line is that there's no game-changing treatments out there and it's arguably a gamble to bet that there will be a vaccine within 12 months.
• Too many businesses will not recover: As businesses open back up, many are beginning in a weak financial position and will fail if consumer demand does not soon return to save them. There will be many more businesses than J. Crew filing for bankruptcy.
• Ripple effect of economic pain: A primary reason recessions are rarely brief is that economic pain begets more economic pain, which then erodes at business and consumer confidence. When people are short on money, they naturally spend less. If consumers spend minimally on products and services, the manufacturers and providers of those products also spend minimally, meaning they're not hiring or investing capital for growth. Consumers and businesses are merely holding on for survival. In this environment, unemployment remains at elevated levels and the ripple effects continue. 

This Time It's Different: 'Dangerous' or Not?

The legendary investor, Sir John Templeton, once said: "The four most dangerous words of investing are: This time it's different." The idea here is that investors have always been proven, after the fact, to be foolish in assuming that the fundamental rules of investing no longer apply. This foolishness can be either on an extreme bullish side or the extreme bearish side.

The last time the investor crowd thought "this time it's different" (in an extremely bullish way) was during the tech bubble of the late 90s, when investors threw the old fundamentals out the window, rationalizing that the new Information Age and the seemingly limitless possibilities of Internet commerce justified extremely high stock prices. To put it simply, they were terribly and famously wrong. 

Here's how the buyers in April could be proven right, thinking that it's different this time, and we won't see a return of the March lows:

The Covid-19 recession is an outlier: This assumes that the March 2020 bear market and the associated recession, as deep as they were, will be the shortest in US history.  

There will be a V-shaped recovery: This implies a return to 2019 economic health without any major disruption from this point forward. This would also mean that stocks, as measured by the S&P 500, would need to climb another 18% from current levels and that job losses and the recession would bottom out and begin recovery before the end of 2020 (stock prices are forward-looking between 6 and 9 months).

All or most of consumer activity will return to 2019 levels: This assumes employers will rehire furloughed workers, consumers will return to travel in full force, restaurants will be crowded again and the massive and growing debt levels will be ignored, as people spend like they'll never be unemployed again.

There will be a Covid-19 treatment and/or vaccine soon: While this is possible, it also assumes there will be little or no resurgence of coronavirus cases after the economy opens back up.

Don't Forget About Irrationality

As legendary economist, John Maynard Keynes, said, "Markets can stay irrational longer than you can stay solvent." This is true on the upside and the downside. Investors can keep buying longer than a rational investor might expect. They can also continue selling longer than any rational thought might justify. This should tell you that market timing almost never works. And even though the crowd may be irrational at times, it's not wise to completely move against it. 

The "sell in May" mindset seems to be rational but if the Covid-19 bear market and recession are short by historical standards, the April buyers could be proven right: things really are different this time.

But there is a third investor mindset, which is a combination of both: March was a buying opportunity, April was a holding period (not an entry or exit), and the next several months will produce more buying opportunities.

Bottom Line

It's never really different: Stock prices always revert to the mean. Before the coronavirus bear market came along, the US stock market had already completed its longest bull market run in history. The 10-year annualized return on the S&P 500 index was 13.5%. The average, or mean, for stocks is 8-10%, depending upon which historical standard is used. Through the end of April 2020, the 10-year annualized return on the S&P 500 still sat at 11.6%. Put simply, there is more mean reversion to come.

But you don't need to sell in May: For a long-term investor, it's wise to stay invested through all market environments.  Remember that 80-90% of gains for stocks occur on less than 10% of trading days. You can't afford to be completely on the sidelines during these days. But a tactical investor may not always remain 100% invested. This investor may remain mostly invested but build cash when the investor herd is irrational on the upside, then use that cash to buy when they are irrational on the downside.

Tactical asset allocation is not "buy low, sell high" in the absolute sense; it's buy some lower, sell some higher, yet remain mostly allocated to core holdings at all times and stay focused on the long term. Always try to take advantage of dollar-cost averaging lower.

If you're not the type of investor that watches markets closely, you may simply make periodic contributions to your investment accounts and rebalance your portfolio on a regular basis.

Most importantly, remember that there are many things in life more important than money.

Be well, my friends.

Kent Thune is a philosopher who happens to be a Certified Financial Planner (TM) and owner of Atlantic Capital Investments, LLC, a registered investment advisory firm located in Hilton Head Island, SC. Mr. Thune is also a freelance writer published on multiple investing and finance websites, including MarketWatch, Yahoo Finance, Kiplinger.com, InvestorPlace.com, The Balance, and The Motley Fool.