By Guest Blogger Ryan Lewenza
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What is happening in these markets?!
I think some people have lost their minds and are throwing caution to the wind. If some people are not careful, someone could get hurt. I’m of course talking about GameStop and AMC Entertainment, which have exploded in value due to Robinhood-horny trading junkies who are joining forces on web chatrooms, essentially pumping and dumping struggling companies to boost their stock prices and profits and cause much pain to the hedge fund companies that are short these very securities. Basically there is a Wall Street ‘David and Goliath’ story currently unfolding on Wall Street and beyond, with billions at stake. Let me explain.
For a number of years there has been a trend of ‘democratization’ of financial services, which basically means making banking and investing easier through the use of technology. This includes things like online banking, lower and more transparent fees, ETFs, roboadvisors, a greater use of technology and specifically apps and chatrooms. Robinhood was the latest iteration of this long-term trend.
Robinhood is a financial technology (fintech) company that combines commission free online trading with an investing app where investors communicate with one another. In these chatrooms, and others like Reddit, they pitch ideas and try to get everyone on board and move stock prices. Well, they’ve been quite successful lately since these renegade day traders have pushed a few struggling US companies from rags to riches in just days, shocking even this well-seasoned investor.
The company getting the most press is GameStop, which, as can be seen below, has skyrocketed from $20 a few weeks ago to $350 on January 27th. How can a struggling company rise 16 times in just a week or two?
First, these Reddit investors look for beaten down companies with large short positions. A short position is simply selling the stock first, then hoping it goes down and buying it back at a lower price. There are a number of big hedge funds that are short these struggling companies with the belief they will fall further and they aim to profit from this.
Second, once they have their short targets they start talking it up in their chatrooms, trying to induce others to start buying shares in the company and getting it moving higher. As this happens it starts to feed on itself as more and more investors rush to buy the stock and bid it up. Then the hedge funds, who are short the stock, get ‘squeezed’ where they have to put in more money as their position drops in value. It becomes a kind of negative feedback loop where more and more investors pile, pushing up prices higher and higher until it inevitably pops.
Some view this as the small retail investor getting back at the big bad hedge funds, who have no qualms over shorting stocks and trying to force companies into oblivion. Essentially, they are getting some of their own medicine.
My problem with all this is: 1) the potential impact to the broader markets and financial stability; and 2) it’s based 100% on pure speculation and market manipulation rather than based on any fundamental research or real economic value. GameStop’s market cap went from US$1 billion at the start of the year to $25 billion in a few weeks! If that’s not rampant speculation and froth then I don’t know what is!
GameStop Rallied from $20 to over $350 in Just Two Weeks
Source: Stockcharts.com
But it’s not just GameStop and AMC where I’m seeing some ‘bubbly’ conditions. Turning to the next market darling – Tesla. Yes I get it, it’s an amazing company on the cusp of a new revolution, but it’s still just a car company, who soon will have much more competition (GM just announced that it will stop selling gas powered cars by 2035). Consider this.
Tesla’s market cap has increased from US$80 billion a year ago to US$850 billion today, just shy of a trillion dollars. If we sum up General Motors and Ford Motor Co, their combined market cap sits at just US$125 billion today. So Tesla is nearly 6 times bigger than both companies combined!
And what do you get for this?
Last year Ford and GM’s revenues were a combined US$240 billion versus Tesla at US$30 billion. On total car sales, Ford and GM sold a combined 7.5 million cars to Tesla’s 500,000 cars last year.
I get that Tesla’s growth prospects are much higher, it’s the extreme valuations I have a problem with.
Tesla is Worth More than GM and Ford Combined
Source: Bloomberg, Turner Investments
I would be remiss if I didn’t bring up Bitcoin. It’s price has surged from US$7,000 a year ago to US$32,000 today or an increase of 3.5 times. I fully admit that I’m stumped about Bitcoin and where it’s heading since I believe it’s based on little actual monetary value. But at the same time, there is a lot demand for a relatively finite currency. If more money is flowing into an asset with limited supply then it could easily go higher in the short-term. But I remain steadfast in my belief that bitcoin is in a bubble and one day could pop.
Is Bitcoin in a Bubble?
Source: Bloomberg, Turner Investments
Lastly, this article (https://ca.yahoo.com/news/robinhood-traders-covid-stocks-142924970.html) gave me a good chuckle recently. It profiles this young couple on how they are making all this money from trading on Robinhood and apparently its super easy. From the article I liked this quote the most, “I see a stock going up, and I buy it. And I just watch it until it stops going up, and then I sell it. And I do that over and over, and it pays for our whole lifestyle.” So that’s what I’ve been doing wrong all these years! I have seen this mania before and it generally doesn’t end well. These traders are confusing luck for skill!
So I am seeing some areas of ‘bubbly’ conditions, but to be clear, I don’t believe this translates into an overall market bubble like that seen in 2000. As I outlined in our outlook report I see the potential for a big economic recovery this year, higher corporate earnings, and very supportive central banks. Give this we’re still bullish on the equity markets for this year, but these ‘bubbly’ conditions could lead to some short-term volatility so be prepared and as always, stick with the balanced and diversified portfolio.
Ryan Lewenza, CFA, CMT is a Partner and Portfolio Manager with Turner Investments, and a Senior Vice President, Private Client Group, of Raymond James Ltd.