Afford Anything - PSA Thursday: Wall Street Bets, GameStop, and the Rise of Meme Stocks

Episode Date: January 28, 2021

If you blinked, you missed the biggest stock market story since the crash of March 2020. It’s a story that led GameStop, a brick-and-mortar company that sells *physical* video games (remember when games came on 5.25-inch floppy disks?), to skyrocket its share price by 700 percent in two weeks. It’s a story of short selling, of high-frequency trading, and of individual investors who harbor deep anger towards hedge funds. It’s a story of social media vs. Wall Street ... and the innocent bystanders who get caught in the crossfire. That's the story we cover in today's episode. For more information, visit the show notes at https://affordanything.com/psathursday Learn more about your ad choices. Visit podcastchoices.com/adchoices

Welcome to PSA Thursday. This is a weekly-ish, really occasional bonus segment of the Afford Anything podcast in which we talk about how to manage your money in the context of, well, originally it was in the context of 2020 and I was hoping that after 2020 would be over, we could stop PSA Thursdays because we wouldn't be needing them anymore. But things are still weird. And so today we're going to talk about meme stocks. That's a phrase I never thought I'd say. I love memes. I love stocks. Never thought that they would be put together, but here we are. For those of you who are brand new to the Afford Anything podcast, PSA Thursday is absolutely nothing like our normal shows. As I mentioned, it was intended to address current events. We created it in March 2020 right after the shutdowns began, right after the pandemic began, to discuss how to manage your money, your time, your limited resources in the context of all of the changes that were happening around us.

in the context of the shutdowns and the current events. And so if you go through our PSA Thursday archives, you will find episodes that we've done that relate to how to manage your student debts in the context of the CARES Act and in the context of all of the changes to the rules that have been made in the past year. We've talked about how to open a donor advised fund if you are in a position to donate to charitable groups and the events of 2020 have inspired you to do so.

You can find all of those previous episodes in our archives, which are available at afford anything.com slash PSA Thursday. As I mentioned, I was hoping to be able to wind this down that we would return to normalcy. But this week got weird in the world of investments. As of the time that I am recording this, which is Wednesday morning at about 10 a.m. Eastern, multiple trading platforms are down or experiencing intermittent service. And that includes Robin Hood, E-Trade, Charles Schwab, TD Ameritrade, Weebel, Thinkerswim, RBC Direct Investing, Fidelity, Vanguard, and much more. Why? Well, the reason leads back to short sellers, high-frequency trading algorithms, GameStop, and a subreddit called Wall Street Betts that has shown an ability to create major price moves in the market, essentially that has shown an ability to manipulate the market. So what is going on? How has this all gotten so weird? Why did Gamestock grow 700% in a day? Why is Robin Hood down? And what does this mean for you?

Let's lay some groundwork. So there's a subreddit called Wall Street Betts. It has 3.1 million users. Every now and again, users on Wall Street Betts collectively decide that they want to all invest in a given stock. Through that collective action, they're able to drive the price of that stock up. Now, most recently and most dramatically, as of the time of this recording, that happened with GameStop, which was a brick and mortar company. Now, GameStop, for those of you who are not familiar with it, was a mid-sized retailer that people who grew up in the 90s have fond nostalgic memories of.

They sold physical video games. But at this point, they're a legacy business. Over the years, their stock had tanked and had stayed low because they're a legacy brick-and-mortar business that sells physical video games. I mean, the reason is obvious. It doesn't seem to have much of a future in a digital world. And yet, thanks to Wall Street bets, the stock rose 700% in the last two weeks, including a rise of 160% in just a few hours on Monday morning,

which then fell, but then rose again to spectacular dramatic effect on Tuesday, rising 300% in a single day. What's notable is not GameStop's rise. What's notable is not GameStop the company itself. What's notable is the reason that it rose. And the reason it rose is because the meme stock era has arrived. That's the weird part. Hundreds of thousands of individual investors gathering on subredits and then placing trades on Robin Hood,

pile into forgotten companies and drive up the prices. GameStop is the one that everybody is talking about right now. But last year, the same thing happened to Hertz and Kodak. And other stocks that the subreditors are looking at include AMC theaters, Nokia, and Blackberry. Piling into meme stocks is a short-term speculative bubble. Investors take cues from one another. The prices go up because the price is going up. People buy not because of underlying fundamentals, but because people believe that other people will buy it, and so it becomes a self-perpetuating prophecy until it doesn't anymore.

These companies don't appear to have futures that are genuinely great. AMC theaters, Blackberry, Nokia, Kodak, no one is suggesting that these companies have underlying business models that are ready to make a comeback. In fact, it's precisely for that reason that it catches the attention of the meme stock brigade. Because of the fact that the underlying fundamentals are so weak, many institutional investors, many hedge funds have shorted these stocks, meaning that they're placing bets that the stock price will fall. And so, because a lot of hedge funds have short positions in these stocks, the Wall Street Bet's subreddit crowd says, hey, we can stick it to the man by piling into a stock that's being heavily

shorted. And so to understand what's happening with GameStop right now and with the meme stock craze in general, let's pause for a minute and dive into exactly what shorting a stock is. So if someone thinks that a stock is going to go down or if someone thinks that a company is going to go bankrupt, the way that a person shorts a stock is that they borrow shares from their broker in order to open what's called a short position. Then they sell shares immediately at the current market price and they have a specified period of time to return their borrowed shares back to the brokerage. So if the stock goes down, the investor buys that number of shares at the now lower current market price and then returns them to the broker and the investor keeps the difference. So

you sell shares today, you borrow shares from your broker that you have the option to purchase in the future. And if you're correct and the price of the stock does continue to fall, you then exercise that option to buy those shares in the future at a lower price, return those shares to the broker from which you borrowed, and then arbitrage of that difference, right? That is fundamentally what shorting a stock is. But if the stock goes up, then the who's shorting has to cover their position. Now, they have the ability to do this whenever they want. If they see the stock price rising and they think it's going to continue to rise, they can proactively decide to close out their position and limit their losses, eat a small loss,

eat a minor loss. They can choose to do that. But if they think that the rise in prices is just a temporary blip and that eventually it will go down, and if they believe that the stock price will go down prior to the deadline at which they need to return their borrowed shares to the brokerage, then what they can do is just wait. As long as they're within their specified time period, they're allowed to wait. What happens is if the price rapidly skyrockets, then the brokerage can force them to sell. Essentially, it's almost the equivalent of a lender calling a loan and forcing a balloon payment, it's analogous to that. The brokerage can call the investor and demand the shares come back to the broker so that

the broker can hedge their losses. And that forced buying drives the price up even further. And when that happens, that causes even more brokerages to make that same call to their clients. And that's what's referred to as a short squeeze. this exacerbates the trend that the more a stock price goes up, the more it keeps going up, not only because buyers are buying it, but because those who shorted it are getting squeezed. So the combined effect of the two, coupled with the fact that the stocks that the subreditors are finding,

these meme stocks, tend to be stocks with relatively small market caps and low floats, that there are not that many shares outstanding, meaning that if a whole bunch of people pile into them that can have a greater impact on driving up the price, because supply and demand, if there are not that many shares outstanding and there's a ton of demand for it, then that buying pressure drives up the price. So all of those factors come together to rapidly, rapidly drive up the price of a meme stock. And that is how GameStop is up 700% in two weeks. Blackberry, as of the time of this recording on Wednesday,

Blackberry is up 185%. And there is so much trading volume going on right now that Robin Hood is down and there are reports online of people being able to log in to Vanguard accounts, Charles Schwab accounts, E-Trade accounts, TD Ameritrade accounts, Fidelity, Honeywell. I mean, there are reports as of Wednesday morning of people being unable to log into all of these accounts.

either because there's possibly a cyber attack going on. This is an ongoing issue as of the time of this recording. Maybe there's a cyber attack. Maybe it's volume. Who knows? But this is how weird the meme stock run has gotten. And this is how much of an impact it is making on the overall market on trading platforms. This morning there was a major hedge fund that announced that it's going bankrupt.

It's done. It got wiped out in the last three days, largely because it had short positions that are no longer. And if you listen to the people who are on the Wall Street Bet subreddit, they will say that that is part of their cause, that they like the fact that they are pushing hedge funds under, particularly those that shorted companies that they liked, particularly those that interfered with the progress, as they see it, of companies that may have had a chance of making a comeback except for all of those who shorted them. thus keeping them down. So they see it not only as a way to generate profits, but also as the triumph of the retail investor, the triumph of the individual investor over manipulations that come from major institutions. And while I think that there's plenty to criticize about Wall Street vets, there is something to be said for the fact that they are demonstrating that it is no long,

the case that only major institutions can manipulate the market, that a concerted group, a unified group of individual investors gathering on the internet can come together and make the market act in incredibly weird ways. There is absolutely something to be said for that. However, there are plenty of victims that are created along the way. And those victims are not always the villains in the story. Those who are left. holding the bag after the pump and dump has come to its end, those who are left holding overinflated shares of GameStop or Blackberry or Nokia, many of those people who are going to be left holding the bag are the grandpas and the grandmas who aren't on Reddit, who don't

understand the phrase 4chan with a Bloomberg terminal, but who watch the news and they saw that these stocks have been runaway takeoffs, and they don't totally understand why or what's going on, but they know that their cat needs medication, and so grandma and grandpa invest their stimulus check in the hope of covering the vet bills, thus becoming the innocent casualties of the pump and dump. So is there a David and Goliath story?

Absolutely, and who doesn't love a good David and Goliath story here? But does the battle between David and Goliath have bystander casualties? Also absolutely. And so what does that mean for you? Should you get in the game? Well, by the time that all of the major news outlets are covering it, it's too late. Despite the fact that there are rallying cries on Wall Street bets to hold your positions, hold your positions. Enough people who want to lock in their gains will begin to sell.

You know, if you're 34 and you still live in your mom's basement, you started with $10,000 and then you saw 700% growth over the span of two weeks. No matter how strong the social pressure is, the rallying cry is we can hold for longer than you can stay solvent, you meaning the hedge funds. But no matter how loud that rallying cry is, there will be enough people who act in their own self-interest, lock in their gains, and then you have a tragedy of the common situation. GameStop is game theory. Robin Hood was a sponsor of this show for a while,

and we were running a promotion. I think it's still active. We're still running it. I think the link still works, where if you open a Robin Hood account using our link, you get a free stock. The free stock that they give out is usually worth just a few bucks. They were giving out GameStop stock,

which at the time was worth about $3. That $3 stock is today, as of Wednesday morning, worth 210. When we see that kind of rapid rise, the Get Rich Quickly story, it's so tempting to pile in, but the exhilaration of trading momentum can be the precursor to a crash and burn.

Trading momentum is like driving a car really fast. You speed and it's exhilarating for a while and then you crash. And you might survive the crash, you might not, but one way or the other, it's dangerous. And if you absolutely can't resist, if you're one of those people who's like, oh, I can't just sit on my hands and do nothing while all of this madness is going on, then if you do want to play, which I don't recommend, but I understand the temptation. It's like eating dessert. Not to use too many metaphors here, but you know it's bad for you, but you do it anyway. If you absolutely must, spend only an amount that you're willing to lose, $500, $1,000, $1,000. If you could lose $1,000 and say, hey, cool, that was as much fun as using that same grand to go on vacation. Okay, cool.

That's your vacation money. Go on vacation, enjoy. But keep it to that thousand. Keep it to that tiny amount. And don't bet your pets veterinary bills on it. Don't bet your rent on it. Don't bet your groceries on it. What's interesting to me about the story of meme stocks is that there are two stories being

told concurrently. One is a story of speculation, irrational exuberance, trading momentum, of bubbles being formed. And that's really what they are. When you've got grandpa who has never talked about any of this before, who doesn't know how to execute a trade, when you've got these nobs learning how to trade a stock so that they can get in on the AMC theater's Blackberry Nokia action, not knowing what they're buying, not knowing why. All right, that's one of the stories that's going on here. And that's why I want to just emphasize that it's dangerous, don't give in. And if you absolutely, absolutely must, then think of it in the same way that you think of going to a casino at Las Vegas. That's the financial story, right? That's the story of the speculation,

the bubble. But there's a different story that's also being told concurrently, and that's the story that it's not about the money, it's about sending a message. The story of the power of the individual investor. That's the story that you hear when you're in that subreddit. And it's interesting to me that these two stories are being told concurrently because it's almost a way of moralizing or morally justifying getting pulled into the speculative bubble. It's a way to create a defense and to preserve a sense of identity in which if you you do end up completely losing your shirt on it. You can tell yourself the story, oh, I stayed in because I'm a good person.

It wasn't because I was greedy. It wasn't the Warren Buffett, you know, be fearful when others are greedy. I wasn't greedy. In fact, I was the opposite. I was being a good person and sending a message. That's the story that people are able to tell themselves to justify buying, to justify holding, and to feel better about themselves when they inevitably lose. It is a psychological defense.

I think most of us here have heard that famous Warren Buffett aphorism, be greedy when others are fearful, be fearful when others are greedy. What's happening right now is that others are greedy, and that is cause to be fearful. And what's happening right now is others are convincing themselves that they are not greedy because this has been positioned as an anti-Wall Street uprising, as the triumph of the little guy, as a social cause,

and that type of positioning may feel good, but it only allows people to justify what the numbers cannot. Gamestock currently has a $6 billion market cap. It will never make enough money to justify that, and yet the people on Wall Street bets piling into this can say, well, this is really about taking collective action. We believe in GameStop. We believe that it is ready for a turnaround. And they may be right that GameStop would be ready for a turnaround.

Ryan Cohen, who is the founder of Chewy.com, he bought about 13% of the company. He joined the board. He brought some people who he really respects to the board. He is really trying to turn around GameStop. So certainly back when it was trading at $4 a share, if you wanted to take a long position in it and say, hey, I think that this thing is going to turn around in the next three, four years, sure, at four bucks a share, that might have been worth it. A long position, a buy and hold, absolutely. You know, you can signal your support for a company without having to create an internet movement that drives up prices by 700% in two weeks. when that happens, it's no longer about supporting GameStop. It's about taking down the hedge funds.

And that is what a lot of Redditors would say. You know, they're anti-establishment. They don't like the hedge funds. They don't like the market manipulations that the big players get to do. There's a lot of justified anger there. When the big players get it wrong, they get a bailout. When the little players get it wrong, they go back to their jobs waiting tables. And so the cause sounds valiant and it's a lovely story, but the problem is that ultimately it hurts the very people that it purports to help.

Ultimately, it hurts grandma and grandpa who invest their social security check, hoping to make some quick returns in the next two weeks so that they can replace the timing belt on their 12-year-old Honda Civic. ultimately when the chips fall and they will, those are the people who are going to get hurt. So the key takeaway is be fearful when others are greedy. Right now, others are greedy. They've constructed a narrative that allows them to tell themselves that they're not, but right now others are greedy. And so it is time to be fearful. As someone on Twitter said, the lack of fear,

to catastrophe. So stay away, don't get caught up in the hype. If you absolutely must, if you or someone you know cannot resist, keep it contained to no more than what you are willing to spend on a weekend vacation so that the maximum amount that you end up losing, the maximum impact that it has on your life is that when all your buddies go drinking at the lake next weekend, well, not next weekend, we're in a pandemic. When all your buddies go drinking at the lake in September for Labor Day weekend, you have to say, sorry, I'm sitting this one out, right? If you limit your losses to no more than missing out on a Labor Day weekend festivities with your friends, okay, fine. We're talking a thousand dollars at the most. We're talking play

money, gambling money, casino money. That's all. Well, that is PSA Thursday for this week. PSA Thursday, of course, is a sporadic segment. It doesn't happen every Thursday. It just happens whenever it's needed. And right now, with the rise of meme stocks and the craziness of Wall Street, it seemed like a little check-in was needed. So thank you so much for tuning in. My name is Paul of Hant.

This is the Afford- Anything podcast. Make sure that you hit subscribe or follow in whatever app you're using to listen to this show. And we have a 31-day challenge to help you. kick off the year 2021 in a way that is strong. So join our 31 day challenge. It's totally free. You can join that at Afford Anything.com slash 31 day challenge. To read the show notes for today's episode, head to Afford Anything.com slash PSA Thursday. Thanks so much for tuning in and I will catch you in the next episode.