By Roy Zimmerhansl, practice lead at Pierpoint Financial Consulting
This is the first of a three-part blog post covering the GameStop story.
It was mid-August 2008, and it had been a crazy year. A year before, in August 2007, the beginning of what we now refer to as the Global Financial Crisis began – described at the time by BNP Paribas in a statement as "the complete evaporation of liquidity in certain segments of the US securitization market”. There was a dramatic spike in the TED spread (differential between LIBOR rates and US government 3-month treasury bill rate), indicating banks believed the risks in having exposure to each other had significantly increased. As measured by the MSCI, the global stock markets had peaked by October that year and continued to fall. There was a relentless torrent of negative coverage on short selling, and all the world's problems were being blamed on short-sellers and, by implication, securities lending.
I decided to do two things: launch a blog to discuss securities lending and related issues more openly and start a LinkedIn group where people could feel comfortable participating in this business. In the 1990s and even after that, I have been critical at times of the securities lending business's lack of openness. I'm very pleased to have been an ISLA board member when it decided to mimic the semi-annual repo update reports produced by ICMA, as that was a refreshing initiative to be more transparent to the world about securities lending.
Financial markets often move in decade-ish long cycles. For example, I moved to the UK in July 1987, just in time to see "Black Monday” the October 1987 market crash. The Asian Financial Crisis followed that in 1997, followed swiftly by the Dot-com bubble, which burst in 2001/2002. Then the GFC (2007/2008) and last year's dramatic spring fall (2020).
This year we have seen the extraordinary events surrounding GameStop and other meme stocks with a subsequent round of attacks on short-sellers and questions about securities lending. I often get asked when speaking or teaching whether I think short selling will be outlawed around the world. My answer is always the same – it has always been controversial with people complaining about it from as early as the 1600s, with intermittent bans, inquiries, suspensions, rules, regulations etc., yet it is still with us. I also suggest that in 400 more years, it will probably still be with us and still be as controversial for some observers.
Short selling effect on Companies
It is important to remember that short-sellers do not impact the day to day business operations of their target companies. WallStreetBets (WSB) driving a price rise does not help GameStop be more profitable or change the economic performance of GameStop. It still has the same issues and opportunities it had at the end of August last year when it was trading at just over $5 a share. WSB aren't company saviours of GameStop or any of the other meme stocks, but Ryan Cohen might be.
How could GameStop have benefitted from all this interest? If WSB fans had taken the money they spent buying stocks and gone down to the mall and bought products at GameStop shops, the company would have been better off. Or if GameStop had used this massive share price rise to raise additional capital to improve its business prospects, WSB actions would have helped the company.
As it turns out, no money has been raised yet. There are two substantial tangible changes that have come over the past few months. First is that the CFO resigned recently. That is often seen as a negative for a company, however, in this case, it may be an opportunity to help push for change along the lines of Ryan Cohen’s strategy proposal. Second is Cohen’s arrival on the board, which has given investors hope for a renewed future. That hope was given a boost on 8 March with GameStop’s announcement of the formation of a Strategic Planning and Capital Allocation Committee to that will accelerate its transformation, with Cohen serving as Chairperson of the committee.
It’s probably worth noting that Keith Gill (aka Roaring Kitty), the GameStop investor that also testified in front of Congress, released numerous videos on GameStop last year making a case for a potential GameStop turnaround. During his testimony to US politicians a couple of weeks ago, he said he thought the stock was still attractive in the $40-45 range where it was trading at the time. On the other hand, Melvin Capital’s CEO Gabriel Plotkin advised that they held short positions for over six years, although as at the date of his appearance in front of Congress, the position had been closed.
In the end, both the short position expecting it to rise or fall are just opinions, nothing more than that, and it is these opposing views that create a market. Investors may win or lose, but the company carries on irrespective of these ups and downs. Investors in GameStop need to hope Cohen and the board change the future prospects for the company, or the share price will inevitably fall again in future.
David vs Goliath
Everybody loves a good small guy vs the establishment story – generally, we love underdogs, and the GameStop story is a classic.
The WSB and media coverage has painted it as David vs Goliath, the retail investor sticking it to “The Man”, Wall Street, hedge funds. While unquestionably, it was started by the WSB/Reddit crowd entirely based on stock market pricing dynamics created by hedge funds, that isn’t the whole story.
Don’t think that all the buying volume in January and since was entirely due to the WSB team coining it and short sellers covering their money-losing positions. There were huge tickets traded that along the way may have been more buying by passive funds that are the major GameStop holders but are also likely to have been hedge funds jumping on the momentum bandwagon, as well as funds that have been set up to scan and track social media traffic and trade via algorithms. In May 2020, Robintrack, an application that kept track of Robinhood trading activity, announced on Twitter that it believed that at least four hedge funds were using their data, including D.E. Shaw, Point 72, Two Sigma and CFM. Of course, that was dependent on Robinhood providing data and in August 2020 stopped the API, with Robintrack limiting their info to data prior to the closing of the API. If you believe that these and other hedge funds gave up tracking the social media data, I have some swampland I'd like to sell you.
It also seems inevitable that new short positions were taken out at various price points since the peak, so agile traders (both hedge fund and retail) would have had profit opportunities on the way up and the way down. Hedge funds are profit machines, so they will happily pursue anything that they believe will generate alpha – long or short. That includes trading sometimes with and sometimes against other hedge funds. While it is convenient and easy for the public to lump all hedge funds into a single fungible entity, it isn't reality. CNN Business shows filings at the end of 2020 with Maverick Capital and D.E. Shaw reporting purchases of 2.9 million shares and 2.3 million respectively, taking Maverick to a 6.68% ownership position and D.E. Shaw to 4.07%.
Finally, one of the drivers behind the price momentum is pooled funds, including Mutual Funds (MFs) and ETFs. Passive funds that hold GameStop are price insensitive. If they have fund inflows, they are buyers, and if they have fund outflows, they are sellers, both times at the prevailing market price. Remember that many MFs and ETFs lend securities, so as they buy additional GME, some of that supply is possibly being recycled in new loans to short sellers. How many ETFs hold GameStop? According to ETF.com, 63, holding 10.5 million shares, and according to ETFDB.com, 25 ETFs have GameStop within their top 15 holdings. CNN Business shows the following Top 10 Mutual Funds holding GameStop.
If the news story started with a retail investor movement, it hasn’t been that for some time.
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