Coyote Blog

A group of day traders who congregate and coordinate on various online platforms made a name for themselves over the past week running up the stock price of struggling Gamestop (GME), in the process laying some epic losses on a few high-profile short sellers.  As might be expected in the current political age, the entire body of both economic thought and 90 years of stock market regulatory theory have been thrown out in the ensuing brouhaha in favor of an in-group / out-group narrative, ie underdog economic losers against entrenched billionaire elite insiders.  As Glenn Greenwald describes it:

Although it may be more complex than this once all the facts are all known, this is being treated — by those excited by it and those aghast — as a type of populist uprising, a David v. Goliath tale in which ordinary people united to brilliantly beat Wall Street at its own game, thereby transferring plutocratic wealth back to the public. Oligarchs and their media spokespeople spent all day on CNBC and other pro-Wall-Street outlets expressing outrage and demanding government intervention to protect them from what they regard as this grave injustice.

Given this narrative is already fixed firmly in place, it is almost impossible to comment thoughtfully or discuss it with anyone.  On the one hand these traders aren't doing anything that Carl Icahn did not do to Bill Ackman at Herbalife, and I can' see any reason why their communication channels or ability to trade certain stocks should be shut down.  On the other hand, this sort of crazy volatility is not good for confidence in markets.  Remember that driving GME to unrealistic levels produces everyman millionaires of the folks who were first in and driving the train, but there is no way the stock price levels are sustainable and just as surely a lot of other regular folks, just like the last ones into a pyramid scheme, are going to lose a lot of money.  I will say that this whole narrative of the stock market suddenly becoming a path for the downtrodden common man to make a fortune has a very 1928 vibe to it.

By the way, to understand what is going on, basically these guys attempted and succeeded for a time in cornering the market in GME stock, really no different from any attempt to corner a market in a commodity and drive the price up.  In this case, the wallstreetbets folks are seeking out companies with a very small "float" -- companies that may have a lot of stock outstanding but only a small amount trades actively because of insider and founder shares and shares that have been borrowed and shorted.  Combining a small float with a large short interest can lead to a sharp rise in prices that is accelerated as short-sellers are forced to cover as their losses mount.  As with any such attempt,  whether by the Hunts in silver or these guys in GME, eventually the pyramid can't be sustained and the price collapses again.  When presented this way, it is amazing to me that socialists like Greenwald are cheering on this kind of behavior.  It is a seeming contradiction but I think I know the answer:  short-selling.

I may be overreading this, but a LOT of the support for the WallSteetbets bros seems to be due to the fact that they took down a bunch of prominent short-sellers, who are considered by the public to be barely one step above child molesters on the ethics scale.  Glenn Greenwald, for example, wrote that this is a story about heterodox groups that "unite in opposition to hedge fund short sellers, who contribute nothing of value."  Had these folks united instead to hammer a popular stock like Apple or Tesla down, I am pretty sure the receptions would have been VERY different, even though the basic narrative would be identical.

So is short-selling really a plague that contributes nothing of value?  I have argued many times that it is very valuable.  But let me try again.

Markets don't have a purpose per se beyond the facilitation of individual goals.  Individuals come together in mutually beneficial trades that create value for both parties.  This is ultimately true of capital markets like any other market -- some people want a place where their savings can earn more than in a checking account, and other parties need these funds to support their business operations and growth.  Individual investors shift their money around as the perceive better risk/reward opportunities for their investment.  This is what capital markets were created for, not to serve some higher macro-economic purpose.

But they do serve a higher purpose, and the reason is at the heart of the magic of capitalism.  Because we know that well-functioning markets with clearly understood and consistent rules populated by folks just trying to look after themselves are critical to a productive, growing economy.  At the heart of this magic is the market's role in the efficient allocation of capital to the most productive enterprises.  Again, this all occurs bottom up.   If there are two widget manufacturers making identical products, but one produces them twice as expensively as the other, we are all going to be better off long-term if the more efficient company thrives.  This tends to happen naturally in the capital markets -- more productive companies get more capital, less productive companies do not.

One of the worst things that can happen in an economy is to have scarce capital misallocated, by some market inefficiency, to unproductive or less productive purposes.   And herein lies the societal benefit of short-sellers. I will not say it is their "purpose", because their purpose is to make money (though a lot of short-sellers are driven by righteous ethical indignation about fraud and ironically often have a higher ethical component to their investment choices than do the longs).  But the larger benefit of the actions of short-sellers is to shift capital away from unproductive companies, because every dollar in capital poured into these companies is a dollar that is not invested in something that creates more wealth and benefits for the world.

Something folks may not know but investors are well aware of it -- there is a large raft of "zombie" corporations out there that shamble along unproductively but still consume huge amounts of scarce capital.   Some have government support (eg Boeing).  Others continue to survive for years eating the seed corn of their past reputation, market position, and infrastructure.  Almost all of them are being supported by the Fed's huge money-printing program that tries to keep both the DJIA and the Fortune 500 afloat.

They were once America’s corporate titans. Beloved household names. Case studies in success.

But now, they’re increasingly looking like something else -- zombies. And their numbers are swelling.

From Boeing Co., Carnival Corp. and Delta Air Lines Inc. to Exxon Mobil Corp. and Macy’s Inc., many of the nation’s most iconic companies aren’t earning enough to cover their interest expenses (a key criterion, as most market experts define it, for zombie status).

More than 200 corporations have joined the ranks of so-called zombie firms since the onset of the pandemic, according to a Bloomberg analysis of financial data from 3,000 of the country’s largest publicly-traded companies. In fact, zombies now account for nearly a quarter of those firms. Even more stark, they’ve added almost $1 trillion of debt to their balance sheets in the span, bringing total obligations to $1.98 trillion. That’s more than the roughly $1.58 trillion zombie companies owed at the peak of the financial crisis.

The consequences for America’s economic recovery are profound. The Federal Reserve’s effort to stave off a rash of bankruptcies by purchasing corporate bonds might very well have prevented another depression. But in helping hundreds of ailing companies gain virtually unfettered access to credit markets, policy makers may inadvertently be directing the flow of capital to unproductive firms, depressing employment and growth for years to come, according to economists.

Even if only half of that is misallocated, that's a trillion dollars of investment capital that could have been better deployed elsewhere.  It's a dead loss to the economy.  Short-sellers are our gladiators trying to bring down some of these zombies.

So let's consider Gamestop (GME).   GME is mainly a group of bricks and mortar stores selling digital content.  Huh?  Stores that sell freaking refrigerators have been hammered by online sales, do we really think that GME makes any sense any more?  But by driving up the price 20x, these supposedly heroic momentum investors are sending a capital market signal that this is the place, in physical stores selling digital content, that the world should put its scarce capital -- not in new bioscience investments, not in electric vehicles, not in new forms of energy technology -- but right here in physical locations next to a Safeway to allow people to buy stuff they could download less expensively in 5 minutes in their own home.  In this context, the GME shorts were freaking heroic.

Updates:

1. To be clear, because I know how these "with us or against us" issues go, just because I am defending the action of short-selling does not mean that I support restrictions on these day traders.  I think Robinhood is making a mistake in restricting trading of its members in GME and I don't like talk of restricting certain Reddit investment forums any more than I support any other proposed restrictions on online speech.  I do think the WallStreetBets folks are being irresponsible to ordinary investors, and high-profile stories of big leveraged wins by some blue collar day traders in momentum strategies is going to result in some huge losses for other small traders getting caught holding the bag at the end of the run.
2. Essentially, the Tesla run up has just been a slow motion duplicate of the GME runnup, with day-traders who ignore any value metric making gains due to the small float, potentially with added manipulation in the call option market.
3. GME is currently down almost $100 per share or 28% from yesterday's close, and down $200 from today's intra-day high.  I wonder if Greenwald wants to celebrate all those underdog investors that bought in <4 hours ago at $200 higher.

Update 2: I do want to thank some group of momentum knuckleheads for driving up the price of mall owner Macerich yesterday.  I sold right at the intraday high (which was 2x the price just 2 days before) and got out whole from a crappy loss position when I thought I was going to have to wait that one out for years.

I need some alert service that says the momentum bros are playing games with such and such stock, get out now while the bagholders are buying.

Update 3:  At one point today GME was trading at 5.5x 2019 revenues -- as a bricks and mortar retailer.  Best Buy, for reference, is trading today at 0.68x 2019 revenues.  And for all its problems, if I had to choose, I would rather own Best Buy than Gamestop.