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The battle of some professionals against the crowd

A battle between independent investors and the professionals has been taking place over GameStop in the US. But such action is no threat to markets – yet.

A battle between independent investors and the professions has been taking place over GameStop in the US. But such action is no threat to markets – yet.

by
Charles Stanley

in Features

03.02.2021

On Tuesday, the people’s army of investors who had successfully bid up GameStop to extreme highs saw their favoured share price plunge by nearly 60%.

Many more people are investing through the stock market. A combination of boredom in lockdown and forced savings from the closure of much travel, entertainment and leisure activity has led to an upsurge of small investor participation in the share markets around the world.

Some small investors are seeking advice and investing for the longer term, with portfolios designed to produce realistic returns and some control of risk. Some are doing that for themselves using brokers and funds to execute transactions.  Others are entering the market as gamblers, relishing the thrills and spills of highly volatile stocks. As long as they can afford to lose their stakes that too can add to the liquidity and interest of markets. Some will do very well by backing an all too volatile stock on the way up and selling out before the share crashes back to reality.

The new phenomenon in an otherwise very old story is the bull raid on a company that the professional investors running the hedge funds have decided to short. The spectacular case of GameStop has opened up old controversies over the practice of shorting and the skills and rewards of some hedge fund managers.

Hedge funds vs the little guy  

GameStop is a relatively small quoted Texan video games and consumer electronics company. It has been recording losses and paying no dividends. By January of this year, hedge funds and others had shorted more shares than the free float capital of the company in the expectation of a share price fall given the company trading issues. Instead, an army of small buyers emerged to carry the share price higher.

They were motivated, in part, by the view that they could themselves create upward momentum in a relatively thin market for the shares and, in part, by thinking they could force the hedge funds to have to buy back the shares they had shorted so pushing the price higher again. Some of them also relished the idea of beating the hedge funds. In interviews, a few have stated they do not like the model of picking on a company with problems, revelling in any bad news it publishes and helping create a run against the company’s shares. There was a moral tilt to the market instincts of some of the buyers.

The buyers chose well with GameStop. Their buying pushed the share price from around $18 in early January to highs well over $300. Clever gamblers amongst this army have now had plenty of chance to book huge profits on early purchases. As the price has soared so it has become very volatile. There has already been plenty of scope to lose large sums and to panic out below a high buying price. Some Hedge funds short of the shares must have had a difficult time, with some rumoured to have closed their positions at large losses.

More regulation ahead?

All this is arousing the interests of both the US Democrat politicians in Congress and the Regulators. The bull army got angry when platforms they used to buy the shares claimed they could no longer access the shares needed and placed controls on their buying. Some in Congress favour controls on short selling and share the dislike of the practice with some of the small investor army. Others dislike both the hedge funds and the small investors and will look at possible rules and taxes to calm things for the future by discouraging both types of speculative activity.

Professional investors are concerned when a company becomes grossly overvalued or a share becomes too volatile. There was no company news in January coming from GameStop to account for such huge changes in valuation. Rational analytical investors cannot predict these big day-to-day changes in price, as it all depends on the balance of forces between the small investor bulls and the large investor bears locked in combat. In the end, both sides will doubtless tire of the battle of GameStop and move on. Both sides will nurse some big losses, and both sides will have some triumphant winners who with luck more than skill judged when was the right time to buy and to sell this share and to bank their gains.

There are a couple of conclusions to be drawn from this experience. The fact that the US stock market pressed on upwards yesterday despite GameStop’s large fall show that so far these battles over relatively illiquid shares are not yet threatening the overall market. Investors generally were impressed by some good company results from Google and Amazon, and by the likelihood of a further stimulus package getting through Congress.   

The ability of small investors to cause losses for professionals undertaking short selling to excess is a reminder to exercise care when choosing professionally managed funds. Some professionals can get carried away and get some investments wrong.  

Nothing on this website should be construed as personal advice based on your circumstances. No news or research item is a personal recommendation to deal.

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