The constant evolution in world view and the innate human desire to improve on history’s past disasters has led to both historic successes and mind-boggling failures. Often in the moment we attribute both these successes and failures to unique circumstances, but as Mark Twain is famously quoted as saying, “history doesn’t repeat, but it often rhymes”. This quote could not be truer today than it was one hundred years before. I am sure you have heard about GameStop, WallStreetBets, and Robinhood through social media, TV, or family over the last couple weeks. I know that I personally had friends, who had never expressed any interest in the market, asking me what was going on. In this blog post, we will explore the historical driving forces behind WallStreetBets, how a seemingly decentralized group of retail investors pulled off one of the greatest short squeezes of all time, and our mindset moving forward.
What do the Great Depression, the Great Recession, and the COVID-19 pandemic have in common and how can market activity from 1929 caution our view of the market today?
The Great Depression
The Great Recession
Occupy Wall Street
Turbulent economic and market environments are never the same, but they often “rhyme”. The Great Depression was highlighted by a crashing stock market after investors took out mortgages on their homes to pour money into the market. Investors at the time believed the market presented an easy way to make money (more on this later). The Great Recession occurred due to major banks competing to issue mortgage-backed securities collateralized by underqualified homeowners on the belief that housing prices only go up. The 2020 market crash, as we know today, was caused by a once in a generation pandemic. While each of these major market crashes seem to be distinct how we react to this distress has gradually evolved from the Great Depression of 1929, the Great Recession of 2008, and informs our response to today’s COVID-19 environment.
During the Great Depression, it was not uncommon to see violent protests and mob looting around the country as people struggled to survive amid the misfortune. They, however, did not focus their animosity on Wall Street, but rather centered it on capitalist nature itself. The Great Recession brought about a new kind of protest called “Occupy Wall Street” in which individuals established encampments along Wall Street in hopes of bringing attention to the expanding wealth gap in America. Today’s “Reddit Revolution”, as I like to refer to it, is a new type of protest. Similarly, to 1929 and 2008, we have a perfect backdrop to fuel protests with sustained unemployment, a widening wealth gap, and a mistrust of the current governmental and economic principles. Today’s protestors are uniquely equipped with several new tools that did not exist in 1929 and were in their infancy in 2008:
- Cellphones and personal computers are no longer considered luxury items and are widely held across all socioeconomic classes.
- Social media (Reddit, Twitter, Facebook, Tik Tok, etc.) are at the foundation of social engagement and for some, the only source of news.
- The information cycle is 24/7/365 and available to anyone with an internet connection.
- Mobile & zero-fee trading now exists across most brokerage platforms.
- Mass stay at home orders and a rapid increase in unemployment suddenly left people with an immense amount of idle time.
- The cancellation of many sporting events and the inability to gamble left gaps in entertainment and distraction.
- Historic fiscal and monetary stimulus drove up savings and drove down interest rates.
What is WallStreetBets and how did they orchestrate a short squeeze on hedge funds?
The aforementioned factors have led to mass adoption in retail trading with estimates of more than 10 million new brokerage accounts opening in 2020. The increase in retail trading has led to stock trading communities across almost every major social media platform. The most famous retail trading community, to date, can be found on Reddit and is known as WallStreetBets (“WSB”). The community was first created in 2012 and was home to a few thousand individuals who gathered to share stock ideas. At least that was what it was designed for until the pandemic resulted in a proliferation of new retail accounts flooding the market. Suddenly individuals were flocking to forums to find and share ideas as the market began to rally. This was the beginning of the WSB transformation. WSB grew from a few thousand individuals in 2012 to roughly 2 million by January 2021, and further increased to 7.5 million today. The decentralized group of retail investors, known on the platform as “degenerates,” ultimately created one of the largest short squeezes in modern financial history. WSB created losses upwards of $19 billion in less than a week for hedge funds that were short GameStop stock.
Short selling is a way for individuals to profit off declining stock prices. Here is a simplified version of how it works: First, you borrow stocks and sell them while their value is high; then, you wait for the price to drop and buy the stocks back to return to the lender. If you borrowed and sold a stock while it was worth $300, then bought it back when it was worth $200, for example, you would earn a profit of $100. This can also work in reverse. If you borrowed and sold a stock while it was worth $300, then bought it back when it was worth $400, for example, you would incur a loss of $100.
In the case of GameStop, the company has long been declining along with other brick and mortar retailers. Hedge funds have recognized their declining financial situation and were short 140% of the stock’s float, which means that some shorted shares had been re-lent and shorted again. WSB and their army of “degenerates” recognized the tremendous leverage that hedge funds and other large institutions had taken out on the assumption that GameStop’s stock would continue to decline, despite its already low valuation. Rather than join Wall Street and short the stock, this decentralized group started to purchase stock en masse, which caused the stock price to rise above the levels that hedge funds had originally sold it. When a short seller is forced to buy back stock in fear of sustaining additional losses, it is known as a short squeeze. A short squeeze typically continues until an equilibrium of sellers and buyers is found and the price stabilizes. Or at least that is what typically occurs. WSB ideology suddenly changed from a way to share ideas about stocks and hopefully make some money along the way to a full-on revolution of the economic system. They saw this as a way for the 99% to flip the tables on the 1%. However, by buying a stock for the sole reason of attacking Wall Street, GameStop’s price became completely detached from fundamentals. In January 2021 alone, one month, the stock has increased 2,463%! It is hard to justify an increase of this magnitude for companies experiencing the highest growth, yet alone a company that has experienced declining revenues over the last decade. As we learned from the market in 1929, purchasing stock regardless of underlying fundamentals to make easy money or make a political point does not end well.
What do we at PYA Waltman Capital take away from the events over the past week?
Here at PYA Waltman Capital, we view moves of this kind as speculative market activity and will not invest your capital in a company that has become completely detached from the fundamental reality in which the business operates. We selectively elect to invest your capital in world class businesses at a fair price. It is important to remember that the stock market has been open since 1817, but the internet first became public in 1993. That means that the stock market has operated with publicly available internet for only 13.7% of its history. With such a small sample size, it would be impossible for anyone to fully understand the impact that evolving technology and internet capabilities can have on the stock market moving forward. Although we cannot predict how GameStop’s stock will move or even how the faceoff between Wall Street and Main Street will end, we can with great confidence say that in the future, there will be economic downturns that bring bouts of sustained distress into the markets. And, although, these downturns will not look exactly like that of 1929, 2008, and 2020, it would not surprise us to see it rhyme. For now, our mantra continues to remain, proceed but with caution.