Traditionally, securities traders make moves that are tethered to the operations and valuation of the companies whose stock they buy and sell. Usually, that works pretty well.
Then this week happened. A digital flash mob originating on Reddit — a popular internet message board — stormed the hedge fund citadel on Tuesday, January 26, 2021, aggressively buying and promoting a series of stocks that the hedge funds held short positions on. GameStop is the most talked-about example, but as of Wednesday the craze had extended to Blackberry; AMC; Bed, Bath, and Beyond; and others. As of writing, short-sellers have lost around $5 billion on GameStop since the beginning of 2021, and $GME is up more than 500%.
The oddity of the runup in stock prices for these downbeat stocks prompted a bunch of institutional investors to wonder what, exactly, happened. Let’s start there.
It’s not hard to guess why hedge funds opened shorts against the retailers in question. What GameStop, AMC, and others have in common is that they’re all legacy businesses based on a heavy physical presence and relatively sparse, cumbersome online businesses. If not for the events of the past few days, and perhaps still in spite of them, some were or still may be headed for bankruptcy sooner rather than later. The hedge funds — established, institutional investors like Citron Research and Melvin Capital — decided to capitalize on the forces pulling these businesses’ valuations down (among others, COVID-19 and the emerging digital-first paradigm). In a vacuum, seems like a good call.
Enter: the internet. A subreddit (sub-forums on Reddit dedicated to specific topics) called ‘WallStreetBets’ took market pessimism about the stocks in question as an opportunity to run up prices. By amassing a small army of retail investors using platforms like Robinhood — which have dramatically accelerated retail investing over the past year by offering 0% commission, fractional investment, and user-friendly mobile applications — a few self-proclaimed finance gurus leveraged volume and surprise to make bank.
Combine emerging platforms like Robinhood with more liquidity than usual — most people who kept their jobs through 2020 faced fewer expenses from traditional outlets like brick-and-mortar retail, fuel, restaurants, etc. — and you’ve got a horde of relatively inexperienced investors pumping cash into stock (incidentally, part of the reason you could argue that the stock market is looking much better than the economy right now).
So, stock prices rose by a few hundred percent. Other institutional investors smelled blood in the water and bought calls, which drove prices even further up. It got worse when this happened:
Musk did the same thing to Etsy on the same day when he tweeted “I kinda love Etsy” and — despite absolutely no changes whatsoever at the company — shares climbed 10% in premarket trading Tuesday.
“The wealthiest man in the world is a meme incarnate. So what?”
It’s worth noting here that Musk’s tweet doesn’t necessarily lend much legitimacy to the effort. Context would clue us into the fact that Musk publicly despises short-sellers. You could argue that for the past few years, shorting Tesla has been hedge funds’ national pastime -- to Musk’s clear disdain.
Believe it or not, this kind of intervention isn’t exactly new. In 2018, Kylie Jenner (I know, right?) tweeted “Sooo does anyone else not open Snapchat anymore? Or is it just me... ugh this is so sad” and Snap Inc. shares dropped more than 6%, shaving off $1.3 billion of the firm’s market value with a table saw.
After Musk tweeted “Gamestonk!!” the price went to the moon. The hedge funds had walked into a short squeeze. Melvin Capital got bailed out by Citadel to the tune of $2.75 billion and closed the short. Citron Research covered their short at 100% losses. The newly-shirtless Wall Street guys were not amused.
Plenty of neutral observers were amused, but the situation also prompted a somewhat-troubling question:
What even is value?
First, the securities market is, well, the securities market. This sort of nonsense just happens sometimes. A stock’s value could be a rational reflection of the underlying company’s expected earnings based on historical performance, but it could reflect a set of speculative predictions with little grounding in current numbers (see: $TSLA). According to some of the r/WallStreetBets ringleaders, this is the whole point. A widely-circulated manifesto published on the site this week includes a claim that “for decades Wall Street was manipulating securities, getting away with it, and blaming it on others.” The manifesto is an interesting read -- and you could say it’s pretty unhinged.
There are a few key observations here.
First, “build-your-own insider trading” could (and probably will) attract a stern eye from the SEC.
Second, most of what we’ve seen in the past few days might not actually be ideologically motivated. Accountability is difficult on the internet frontier. It’s hard to say how many members of r/WallStreetBets wanted to watch the system burn and how many innocuously took what they figured might be a good stock tip, but there’s a reasonably good chance that many of the crowd who bought $GME over the past few days will take their triple-digit returns and get out while they can. A few hardliners might stick around, but these events aren't necessarily going to become a "war on Wall Street." Time will tell, and the crowd is clearly a powerful force, but there is a lot of inertia supporting traditional incumbent structures, and there were clearly profit motives at play for the buyers in the runup.
Lastly, this is simply a lesson that options and shorts are sophisticated investment tools that serve a genuine market-clearing function, but they can be tremendous sources of risk for even the most experienced institutional investors. It’s well-known that hedge funds are relatively risky, but the events of the past week underscored exactly how volatile the market can become — especially as the internet facilitates collaboration on unheard-of scales.
“Alright, so why is a real estate firm weighing in here?”
Our answer: “because this doesn’t really happen to real estate.” The GameStop run-up has definitely been the big water-cooler topic around the (virtual) office for the past couple of days. The possibility that this kind of thing happens is a genuine vulnerability of the stock market, especially when prices become increasingly distant from traditional valuation frameworks.
One of the reasons we like real estate investment is that it simply isn’t exposed to these kinds of risks. A celebrity is much less likely to tweet the value of your apartment building away in the span of 10 minutes, and a Reddit flash mob can’t cost you billions, because — at the end of the day — the value of your investment is tied not to volatile abstractions about future value, but the predictable cash flow of tangible, physical property. A real estate investor can get a good chuckle out of stock market volatility, and be on with the day. That’s one of the reasons we love it, and this week has us doubling down.