Social Day Trader vs Wolf of Wall Street

This past week has been one of the wildest weeks in the equity markets we have seen since the pandemic crashed markets back in March.  But unlike 2020’s pandemic that brought true fear and uncertainty into the global economy and business fundamentals, the end of January 2021 was a social network fueled battle against the establishment.  It was Main Street vs. Wall Street, inertia vs. fundamentals, the shooter vs. craps.

To set the stage, lets take a look at how the market performed in the first month of 2021.Below are two graphs of the major indices; the first is indexed to the closing price on the first day of trading for 2021 and the second is indexed to the closing price on Monday January 25th.As you can see, the major indices have been relatively flat for the month, with the Nasdaq showing better results driven by some of the out-performance of technology stocks.

But over the last week, all of the indices have had a material shift downwards.

Now there are obviously several contributors to the indices that can skew the data, and we have also had some material macro events in the United States with the inauguration of Joe Biden and a reversal of Trumpian policies across multiple industries. So, let’s try and focus in on the Nasdaq and some of the seasoned, large stalwarts that make up that index to see if it paints a different story. Specifically, lets look at how Apple, Inc. and Facebook Inc. performed over the same time period. Both companies reported very strong financial performances for the last quarter of 2020 and despite a looming battle between the two over user privacy, the fundamentals for both of these businesses continue to remain promising. Typically, when established companies exceed analyst expectations and have a promising outlook for continued profitability, the stocks do well. But both Apple and Facebook, limped along this month…

…and suffered some meaningful losses over the past week.

Some of this contrarian performance could be linked to the larger bull run we have had for the last 6 months with the market doing a minor correction, which happens.  But as history has so brutally shown us in the past, fundamentals do always win the day. 

We hate to use the phrase “markets are not perfect”, because that is not really true.  Markets reflect supply and demand perfectly at all times.  You can argue that there is never perfect information nor perfect access to information, but arbitrage investing typically closes those gaps quickly.  What we think most people mean when they say, “markets are not perfect” is “markets don’t match fundamentals”.  But there are plenty of markets where there are no fundamentals at all, but still function perfectly based on supply and demand.  High end art, or niche collectables, for example, can see astronomical prices for rare items.  A portrait by Sandro Botticelli was recently sold by Sotheby’s for $92.5mm, despite being purchased for $1.2mm a mere 40 years ago.  Did the painting “fundamentally” change in 40 years?  Certainly not like the cash flow generation of a company changes in the same time frame.  The only difference was the changes in demand for a one of a kind supply item.  When markets lack true fundamentals, like high-end art, there is only the inertia of supply and demand to drive value.  Typically, the stock markets have had the benefit of operating a bit more logically, or fundamentally, given the very visible and reportable operational health of an investment.  But that is not to say that fundamentals are more important than raw supply and demand and this was never more apparent than in the January 2021 performance of GameStop (NYSE: GME).

GameStop has been on a steady decline over the last 5 years. The company has battled underperformance, high brick and mortar retail exposure and a shift within its industry to streaming services, direct to consumer digital distribution, and even the rise of e-sports cannibalizing consumers. Some very successful and sophisticated investors, namely Andrew Left of Citron Research, identified the headwinds faced by the company and implemented a short-sell strategy to capitalize on the situation. Left and Citron even published the price at which they were shot and their expectations for the decline. Based on fundamentals, this was a very smart bet and a strategy that has made Citron a lot of money in the past. As recently as September 2020 the stock was down ~80% from its indexed price from the start of 2015.

But what Left did not realize was, that in the eyes of the social media driven world, he was betting on craps.

Over the last year the popularity of online retail trading platforms such as Robinhood, have seen a boom in user base and trading activity.  Combine this with free open access communication platforms such as social media app Reddit, and retail investors suddenly had the potential for organized inertia.  Typically, retail investors, which far outnumber institutional investors, have less capital, less access to information and less sophisticated trading tools compared to the Wolves of Wall Street.  But these “David” like social media day traders were able to organize, strategize and implement a sweeping investment approach that crippled the short position of the Wall Street veterans.  In just this week alone GameStop saw over a 300% increase in its price, which was also over 11k% increase from its low during the midst of the pandemic in April 2020!

Obviously, the fundamentals of GameStop have not had such a monumental shift to deliver such returns.  There was just a significant amount of short sold pressure relative to the overall outstanding shares, so there was minimal supply in the daily float.  Combine that with the army of retail investors fueled by the anti-establishment rhetoric on social media and they were able to exhaust the limited supply, driving the stock price above the short sell price, which created even more demand to settle shorts with even less supply, driving the stock up further.

Eventually the GameStop share price will settle back down to fundamental value, just like a shooter in craps will eventually crap out, but the risk of sustaining that short bet against such frenzied inertia is proving too much for even the most sophisticated and well-funded traders. After all you don’t want to be the gold hoarder in a crypto world!

Written by Mike Lambrix.

About Sampford Advisors

Sampford Advisors is a boutique investment bank exclusively focused on mid-market mergers and acquisitions (M&A) for technology, media and telecom (TMT) companies. We have offices in Toronto, ON, Ottawa, ON, and Austin, TX and have done more Canadian mid-market tech M&A transactions than any other adviser.

Photo by Jonathan Petersson on Unsplash