It feels wrong to hope that a company goes out of business and its stock craters to zero, which is why short sellers — the traders who make money when stocks tank — are treated with disdain in many corners of Wall Street and now increasingly in Washington.
But the devil in this case deserves some sympathy. Without short sellers, the investing public is truly doomed. And for proof, look no further than a one-time penny stock that’s headed back to nosebleed levels.
The stock is GameStop, of course, a video-game retailer undergoing a corporate restructuring that includes store closures and, according to many analysts, an outdated business model as people increasingly buy video games online instead of in stores.
As we all now know, GameStop has become a market darling of novice traders for reasons that defy logic — sending the stock to a high of nearly $500 a share a few weeks ago before crashing and then rebounding this week.
Initially, the stock was buoyed by an unusual array of factors, including by chatter on Reddit message boards that the company was bound for greatness. Adding fuel to the fire were novice traders armed with a Robinhood no-fee trading app and a deep desire to stick it to the big boys betting on the stock’s decline.
Short sellers borrow shares of stock, sell them and repay the loan at a later date, betting shares will fall. That’s why they make a lot of money when stocks tank. But they can lose a lot of money when stocks they short rise, which is what happened with GameStop.
The mania sparked a short squeeze and hedge funds got crushed. Robinhood had to halt trading because it didn’t have the capital to settle and process all the trades.
Ultimately, the House Financial Services Committee held a hearing to sort things out. But the committee mainly tried to place the blame on hedge funds that shorted the stock.
What was largely overlooked during the hearings was that even as the hedge funds lost money, they were eventually proven right. As they predicted, shares of GameStop collapsed. Small investors who ignored the short thesis and engaged in the Reddit-induced mania by buying near the top (sometimes with borrowed money) got crushed as the stock plummeted below $50.
Just last week, GameStop’s stock climbed yet again, up to close to $200 a share before settling at just $100, which is still light years above its penny-stock levels of under $4 during last summer. And that’s setting up small investors to get screwed yet again.
I took a stroll through the muck on Reddit’s “r/wallstreetbets” thread, the epicenter of the GameStop tout, to see what, if anything, is being pushed about GameStop’s business model. The answer: very little, though I did find one post from a user who promised to “tattoo wallstreetbets logo on my right butt cheek if we get GME to $1,000.”
Note the language here: “If we get GME to $1,000.” It is typical of stock touting, where traders hype stocks for flimsy reasons. The dumb money comes rushing, pushing shares up further before savvy traders dump their holdings for a profit.
Of course, it’s impossible to know whether GameStop will match $1,000 a share or even the $500 mark it nearly hit during the height of the mania in late January. But this time there are reasons to believe the losses to average investors could be even steeper: There’s an absence of short sellers providing a much-needed second opinion.
Short interest in GameStop that had surpassed more than 100 percent of the float in January has fallen dramatically.
Hammered by the short squeeze and Congress (during the Finance Committee hearings, committee Chair Maxine Waters used the term “predatory” to describe short selling), the shorts are now running for cover. The information flow is being dominated by the touts.
As I reported on Fox Business, legendary short seller James Chanos is worried about the market implications of the anti-short mania that is sweeping retail investors and now possibly Congress.
Chanos, a friend of President Biden, has reached out to economic aides in the White House to convince them short sellers are needed now more than ever. Record low interest rates, no-fee trading apps and message-board hype are creating a perfect storm of small investors snapping up speculative stocks that are likely to implode when reality hits again.
Of course, Chanos is one of those evil short sellers who have made a fortune betting stocks will crash, so consider the source. Recently he made what many touts consider a mistake by stating that Tesla was a “walking insolvency” given where the stock is trading and how the electric-car maker is faring today.
Time will tell if he’s wrong.
But some 20 years ago he made history with research that uncovered one of the great corporate frauds ever: the Enron accounting scandal. Investors who listened to him made money; those who didn’t lost money. Regulators who ignored him were forced to reform accounting laws for greater transparency.
Count me as someone who thinks we need to hear more from the likes of Chanos as markets hit new highs while low interest rates and fee-free trading apps lure more novice investors into thinking that trading is a no-lose situation because that’s what they’re reading on Reddit.
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