What is going on with GameStop?

Jan 29, 2021

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What is going on with GameStop?

Today, we’re going to talk a little bit about what the heck is going on with GameStop and Reddit and some of the other stocks that have gone crazy on the stock exchange over this last week. So, the story right now is that there seems to be a fight between the short-sellers and the buyers of GameStop, and there are other stocks that are doing the same thing. But let’s talk about GameStop because that seems to be the focal point of what’s happening.

Basically what’s going on is that there is a forum called Reddit, and Reddit is a discussion site on the internet where people talk about many things, but one of the the areas is called WallStreetBets. WallStreetBets has been pushing people to buy shares of GameStop. Why? Mainly they’re doing it because the stock was so heavily shorted.

Now, what does short-selling mean? Short-selling means you borrow stock from someone, you then go and sell it on the market, and eventually you have to go buy it back again. So theoretically, there is no limit to how much you can lose because when you buy it, you’ve got to buy it at whatever price the market’s at, and if the market keeps going up, and up and up you’re losing more and more and more. That’s exactly what was happening to some of these hedge funds, specifically Melvin Capital has been pointed out as one that has just been brought to its knees. It had a heavy position that was shorting GameStop. So they expected the stock to go down. Remember they borrow the stock and they have to buy it back at some point. So what they really want is for that stock to go down, they buy it back, and they’ve made money. But what happened is now that all these people on WallStreetBets are saying, “Buy GameStop, buy GameStop, buy GameStop,” and there’s more and more and more people driving the price of GameStop higher, eventually the short-sellers are saying, “Well, wait a minute. I’m losing my rear end on this, so I better start covering that short.” By covering, that means they have to buy it back. But meanwhile, they’re losing more and more money.

On the WallStreetBets site, there are a lot of people who’ve been just cheerleading this, and so a lot of the members of of this particular forum are saying, “We’re all gonna buy it and we’re going to stick it to the hedge funds.” Well, in fact, that’s exactly what they’ve done. And part of me says, “Yay,” because I don’t like it when stocks that I own get shorted, but there’s a reason that stocks get shorted. Mainly it’s because of valuations. A lot of people thought that GameStop was a very poor company and that it really wasn’t worth much at all. I think even some people who are on Reddit right now who are buying the stock might tell you the same thing. But they don’t care.

Now, I will tell you that I think that’s a dangerous game. And why is it dangerous? Because the last one in is going to get their head handed to them, and it’s almost a short squeeze in reverse. So a short squeeze, again, is when a company is shorted, lots of people go in and buy it, the price goes up and the shorts have to cover. When you’ve got lots of people who are buying a stock and it’s going up from what was at $5 or $10 a share to $500, $607 a share, those people who were buying at five or six or $700, they could be exposing themselves to a lot of loss because at some point in time, there has to be a real value for what the company is worth. If the company’s not making money, if the company is not doing well, at some point, that stock price should go down in a normal market. So, be very, very careful if you’re out there doing those things.

Now, the way this is really affecting the rest of the market is that those hedge funds are big. So when they’re losing money, what they have to do is because they’re borrowing money, they’re leveraged, and leverage is always the thing that hurts people. They’ve got to come in and either bring more cash in to cover those positions that they had shorted or they need to sell if they don’t have the money or sell other positions that they have to raise the money. So, what’s happening now is a lot of these hedge funds are starting to sell their winners. Their good stocks, the stocks that a lot of you may own. So there is some danger in that. Now, is it illegal? So far from what I’ve seen, it’s not necessarily illegal, but it’s pushing it because basically what they’re doing is saying, “Let’s all band together to move the price of the stock without any relationship to whether that makes sense or not.” Still not illegal, but I think it skirts the issue. So, the SEC is, of course, going to be investigating.

Meanwhile, one of the firms, Robinhood, which is one of the brokerage firms that a lot of the young people have been on, decided that they were going to stop trading in GameStop and some of these other stocks. The people on Robinhood were very upset. And I don’t blame them. All of a sudden the broker says, “Hey you can’t buy anymore.” I’m not sure that that’s fair.

So, basically what’s happened is you’ve had a giant short squeeze. Be careful though. If it were me, I would not be playing in this particular game because when it goes the other way, it’s going to go fast and this will not end pretty, one way or the other. So, as far as the overall market is concerned, this may be a cause for the market retracting a little bit as some of these stocks are being sold. I don’t think we’re in a recession or anything like that because so far the economic numbers that have come out have been pretty good. Most of the earnings numbers have been pretty good. So, not sure I would get too worried about what’s going on with the whole market. I do expect at some point there’s going to be a retracement of some of these gains. Nothing goes straight to the moon, including GameStop. So, be careful out there. And of course, if you have any questions, you can always give us a call or you can always contact me at WWMFinancial.com.

Steve Wolff is a Managing Partner at WWM Financial in Carlsbad California.

Steve can be reached at 760-692-5190 or click on the following link to contact https://wwmfinancial.com/contact-2

WWM Financial is an SEC Registered Investment Adviser. The opinions expressed in this program are for general informational purposes only and are not intended to provide specific advice or recommendations for any individual or on any specific security. It is only intended to provide education about the financial industry. To determine which investments may be appropriate for you, consult your financial advisor prior to investing. Any past performance discussed during this program is no guarantee of future results. Any indices referenced for comparison are unmanaged and cannot be invested into directly. As always please remember investing involves risk and possible loss of principal capital; please seek advice from a licensed professional.