If you think you've seen some interesting market movements, Wall Street's 2021 start has been a literal "hold my beer" moment.
Last year, investors navigated their way through the steepest bear market decline in history -- 34% lost in 33 calendar days for the benchmark S&P 500 -- as well as the most ferocious bounce-back rally to new highs. Further, the CBOE Volatility Index reached a new all-time high in March 2020, and West Texas Intermediate oil futures contracts dropped to nearly negative $40 per barrel in April 2020.
Then 2021 arrived, and so did YOLO -- you only live once -- stocks.
The internet is an invaluable way to share knowledge. It allows investors access to income statements, balance sheets, investor presentations, and management commentary with the click of a button. But it's also proved to be a dangerous tool in the wrong hands.
GameStop, AMC, and other YOLO stocks have been unstoppable lately
For a little over a week now, the members of the r/WallStreetBets forum on social platform Reddit have turned normal market activity on its head. Members have been seeking out companies with high levels of short interest -- i.e., companies that have a large percentage of investors relative to their total float betting that their share price will drop -- and pumping these companies as stocks to buy. Since short-seller gains are capped at 100% and their losses are unlimited, short-sellers have been forced to buy to cover and close out their positions, fueling a rally in mostly poor-quality companies.
GameStop is just a few months removed from trading at $4 a share. The multichannel video game and accessories retailer is amid a multiyear turnaround. It's shuttering physical stores to reduce costs and spending big on digital gaming initiatives. Though its e-commerce sales are soaring (up 309% during the 2020 holiday season from the prior-year period), GameStop's revenue is heading in the wrong direction. It's produced three consecutive years of losses.
But as of Wednesday, Jan. 27, 2021, GameStop was up 1,745% on a year-to-date basis, nearly 8,600% over the trailing six months, and was sporting a $24 billion market cap.
Movie theater chain AMC Entertainment, which only days ago secured $917 million in new funding through a combination of debt and equity offerings to avert bankruptcy, is up 568% in just four trading sessions and has plowed forward to multiyear highs.
Though the saying that "a stock is worth what investors will pay for it" is accurate, the Reddit community isn't offering bona fide investment advice. These aren't professionals suggesting that GameStop or AMC are worth buying because of their business prospects or outlook. Instead, the activity we're witnessing borders on collusion. A group of retail investors simply wants to see what happens if they try to disrupt normal trading activity by purchasing shares and call options to drive short-sellers out of their positions.
They're playing a dangerous game. Having seen similar pump activity played out a handful of times before over the past 25 years, I can safely say that few are going to come out ahead. Institutional investors will take their licks and eventually be back. Meanwhile, unsuspecting retail investors will learn a hard lesson when their position comes crashing down. The gains in GameStop and AMC Entertainment are in no way sustainable over a long period of time.
New regulations might emerge, but they'll take time to craft
This short-selling/Reddit debacle will probably result in new regulations. I'd surmise that the only reason we haven't seen the Securities and Exchange Commission (SEC) act yet is that they've never seen anything like this before and don't know how best to contain the spread of misinformation in the market or prosecute those involved.
In the past, the SEC has been able to react quickly to blatant examples of securities fraud. However, market manipulation is a lot tougher to weed out, especially when it's being fueled by a community platform with more than 3 million users. Developing a plan to counter this kind of social media activity won't be easy, and it's not going to happen overnight.
But there is some prior precedent. Back in 2000, Yun Soo Oh Park, better known as "Tokyo Joe," was charged with fraud in an SEC civil suit for pumping up companies he had stakes in and exiting those positions before they hit his website's published target price. Essentially, he was a pump-and-dump kingpin. This was the first high-profile instance where the SEC challenged the sharing of investment information on the internet.
Even though r/WallStreetBets on Reddit isn't a paid platform like the one Tokyo Joe ran, the SEC may still have grounds to wield its power on the basis of collective market manipulation. I don't know when the rules will be changed, but GameStop, AMC, and a host of other heavily shorted stocks have almost certainly set the wheels in motion.