One of the greatest excesses of the 2021 bull market was the GameStop (GME) stock saga and the brief meme stock frenzy that saw largely defunct retail names like GME and AMC Entertainment (AMC) and tech company BlackBerry (BB) (as well as now-bankrupt Bed, Bath & Beyond) skyrocket as retail investors piled into shares and options contracts.
At the time of writing, GameStop shares have risen 75% today after more than doubling earlier this morning following repeated halts.
[text_ad]
The catalyst for the move has been a single tweet from Keith Gill (@TheRoaringKitty), the architect of the original GameStop meme trade. The tweet, in its entirety, is below.
That simple image of a gamer leaning forward (shorthand for “pay attention”) has been viewed 13 million times and prompted the trading activity in GameStop mentioned above.
That’s it. That’s the tweet. And GameStop has added somewhere in the neighborhood of $4 billion in market cap in response.
The early rally is already showing signs of fading and will likely leave many early buyers as “bagholders” (online parlance for investors that have taken significant losses on a momentum trade that moves against them, turning them into long-term holders due to the sunk cost fallacy).
GME is best avoided entirely, but the saga does offer two potential lessons that investors can apply on an ongoing basis.
2 Lessons from the GameStop (GME) Stock Redux
1. Understand the short-term catalyst before you invest.
There’s a relevant quote from Benjamin Graham: “In the short run, the market is a voting machine but in the long run it is a weighing machine.”
In other words, short-term market moves are driven by news and investor perception, but long-term market moves are driven by company fundamentals.
There’s nothing wrong with short-term trading, but if you’re making a trade based on a prevailing narrative or news item, you need to have a strong understanding of that catalyst.
In the case of GME, the original meme stock thesis was that there were more shares short than shares outstanding, which would force institutional investors to cover short positions at higher and higher prices as they bid against each other to close shorts.
Last time, that worked. And it drove the initial phase of the GME rally. The second leg of the 2021 rally was driven by what can best be described as an uncoordinated (or loosely coordinated) pump and dump through online message boards.
Without getting too technical, it relied on using long calls to force hedging at higher prices, a feedback loop of rising prices. The only mechanism that sustains that trading is the “greater fool,” the next person willing to come in and buy because they believe they’ll be able to sell shares to the next investor in line.
I’ll go on record saying that I believe Monday’s GME rally will fail quickly because it lacks the original short-interest catalyst. Without that catalyst, we’re simply left with a speculative buying frenzy that’s no different from any other pump and dump. The last wave of “greater fool” buyers are still sitting on losses in excess of 50%, even with today’s rally.
If you don’t have a solid understanding of the rationale behind the big move in shares, you won’t understand when the narrative has changed either.
2. Exuberance appears to be alive and well.
Other than not buying a stock that’s rallying simply because it is rallying, what other lesson can we take from this? I would posit that a refresh of the GameStop stock frenzy is a good indication that even after the recent dip, investors are showing, if not exuberance, at least complacency in the face of high share valuations.
We see similar signs of complacency in the VIX, the so-called fear index, where persistently low levels reflect a lack of hedging by investors.
This is not a shot across the bow for equity investors in any sense. Over the long term, maintaining a bullish posture has proven to be far more successful than a bearish stance. Instead, we should take this as a reminder to remain disciplined with our investing strategies and resist the “fear” and “greed” impulses that most frequently leave individual investors buying high and selling low.
[author_ad]
