Stonks Are Bonkers, and Other Lessons From the Reddit Rebellion
(Bloomberg Businessweek) -- There’s been a rebellion in the stock market, in case you hadn’t noticed. The Battle of GameStop, the stampede of the meme stocks, and the rage against Robinhood were as transfixing as the bursting of the dot-com bubble—only this time the action was focused on a handful of companies associated with 1990s culture, and this time everything was going up. Thanks to traders talking it up on social media, the stock of GameStop Corp., the unprofitable mall retailer of video games, climbed as much as 1,745% from the start of the year. The AMC movie theater chain peaked at a gain of 839%; BlackBerry and Nokia, which once made very popular phones people strapped to their belts, spiked 279% and 68%, respectively; and Koss (headphone maker), Build-a-Bear Workshop (chain of stores that … you know what they do), Tootsie Roll Industries (yes, that Tootsie Roll), and, for some reason, silver all shot up.
The past two weeks broke a lot of people’s brains re: how Wall Street works. One money manager told Bloomberg News that GameStop was his “most-hated stock of all time.” Also, a lot of well-compensated hedge fund managers lost huge sums because they’d been betting on the stocks mentioned above falling. And the frenzy was all caused by an extremely online crowd that Doug Henwood, writing in the leftist publication Jacobin, wryly called “the wrong kind of people. They don’t live in Greenwich in houses with twenty-car garages.”
Instead, they came from the frequently profane Reddit message board WallStreetBets, where posters talk about stocks and often band together to try to move prices. It has its own insider language: “stonks” for stocks and “tendies” for gains, because chicken tenders are a reward for being good (and because it’s funny). Lots of WSB posters don’t buy stocks directly but instead use options, which allow them to take big positions for a relatively small amount of money, a form of leverage that amplifies potential gains as well as risks. They also like to go after the so-called shorts, investors who bet against stocks. The idea is that by pushing up a highly shorted stock, the WSB crowd can “squeeze” shorts into protecting themselves by buying the stock themselves, triggering a (temporary) upward spiral.
WSB’s campaign for GameStop gained steam early on with an investment case made by a poster named DeepF---ingValue, who in offline life, Reuters reported, is a chartered financial analyst who used to work at an insurance company. It can be hard, sifting through the memes, to tell when the Redditors are glomming onto a stock because they truly like the business, or because they think they can manipulate the shares, or because they think it would be hilarious to mess with some hedge funds. Like so many movements that have bubbled up from social media, New York Times tech and media writer John Herrman observed, the GameStop push was sort of a joke until it wasn’t.
And it got political, in ways that have been hard to make sense of in the heat of the moment. What else would bring together the likes of tech-bro idol Elon Musk—who fanned the rally by tweeting “Gamestonk!!”—and progressive U.S. Representative Alexandria Ocasio-Cortez? On Jan. 28, Robinhood Markets, the zero-commission trading platform that’s been the gateway to the market for many young investors, restricted buying in GameStop and other popular Reddit stocks. “This is unacceptable,” AOC tweeted. She called for hearings into why retail investors were blocked “while hedge funds are freely able to trade stocks as they see fit.”
Robinhood later said it had to cut off buying temporarily because the overwhelming demand for those volatile stocks was causing its clearinghouse—a behind-the-scenes organization that makes sure buyers and sellers actually get their stocks and cash—to demand higher deposits. The trading platform eased the restrictions after furiously raising more money. “We didn’t want to stop people from buying stocks, and we certainly weren’t trying to help hedge funds,” the company said in an email to customers.
Still, it was a bad look for a company whose stated mission is to “democratize finance.” Robinhood makes options trading on smartphones easy and nudges users into setting up margin accounts so they can speculate on stock with borrowed money. The GameStop raid showed what tools like that could do. “Until GameStop, it seemed to be much harder to borrow money, speculate, and collude if you weren’t on Wall Street,” wrote Matt Stoller in his economics newsletter Big. At a key moment, Robinhood and other discount brokers realized they couldn’t really keep the playing field level.
But this rebellion was hardly a revolution. Let’s say it plainly: A lot of small investors who jump onto GameStop and the other meme stocks are going to get badly hurt. Some already have been. If you bought GameStop at its peak, you were down 73% as of Feb. 3. Honestly, buy an index fund instead—you’d have made an annual 13.5% if you held on to an S&P 500 tracker for the past decade. And be on guard against market bulls speaking the language of populists.
Before GameStop, the culture of finance was already entering its latest imperial phase, spreading out beyond practitioners and into the consciousness of ordinary savers and working people for the first time since the 2008 real estate collapse. In the interregnum between that crisis and the pandemic, most people were happy to ignore the markets even as they climbed. Cash was still being plowed into stocks, and there was plenty to be earned by big asset managers, but it was an increasingly bureaucratic affair: Human resources departments set up 401(k)s, chunks of paychecks got directed to broadly diversified funds, and Vanguard Group, Fidelity Investments, or BlackRock collected a tiny toll.
Circumstances obviously changed in 2020. The pandemic and the sheer boredom of lockdown, excitement about new technologies, free stock trading—all that and more began to pull people in. It’s hard to put your finger on what triggers market exuberance, but once it gets going it can create what the economist Robert Shiller has described as a feedback loop. Markets do well enough that people start to pay attention, and they start to talk about it and experiment with investing. (The 1960s and 1990s bull markets saw fads for investment clubs, or slow-motion subreddits.) That demand helps push up prices, investors become more confident, and even more people pay even more attention to the market. And so on.
The media is a big part of this, Shiller has noted, and it’s not just Redditors and people like Dave Portnoy, the inexplicably influential founder of Barstool Sports, egging on day traders, but normie journalists who can’t help but cover the GameStop story. Telling you to stick to index funds and not to get your head turned by the 1,745% gains we just told you about is like telling you not to think of a purple hippo. Once your attention is captured, you’re in the feedback loop.
GameStop may have left short-selling hedge funds wheezing. (No sympathy: This is the business they chose.) But in general the popularization of markets works beautifully for the financial industry. The serious money in finance comes from the opposite of shorting—the “long” bets that prices will keep going up. Investors’ willingness to go long is what really fuels the profits that investment banks earn helping companies sell their stocks. It’s the long bet that sells mutual funds and ETFs and cryptocurrency trading apps. And it’s the thrill of the long bet that helps separate everyday investors from their money and rake it into the pockets of Wall Street’s horde of intermediaries.
Look around, and you’ll see a flowering of products and complicated financial structures designed to help you go long. For example, there are special purpose acquisition companies, or SPACs, which raised more money from investors in 2020 than in all previous years combined. Also known as blank checks, they’re public companies with no business except to buy another business. Sometimes they find one that’s hot enough, like Virgin Galactic Holdings Inc. or DraftKings Inc., that the price shoots to the moon. The SPAC maestro behind the Virgin deal, Chamath Palihapitiya, has been outspoken in his support of the Redditors. “Instead of having ‘idea dinners’ or quiet whispered conversations amongst hedge funds in the Hamptons, these kids have the courage to do it transparently in a forum,” he said on CNBC.
Blank-check deals are complex, and it’s not easy to figure out what an ordinary shareholder gets out of them. That’s one of the hallmarks of exuberant times: New investments demand increasingly steep learning curves, because increasingly confident and curious investors are willing to endure the difficulties—or at least overlook them. On SPACs, suffice it to say this: They’re very good deals for the people who start them, who come away with a lot of cheaply acquired stock in a public company. They tend to work out less well for investors who buy in after the SPAC’s initial public offering and hang on after a merger. On average, those investors have lost money, according to a working paper by law professors Michael Klausner and Michael Ohlrogge and consultant Emily Ruan.
Sure, some SPAC promoters might be very adept at finding great deals and helping the companies they acquire grow. But SPAC combinations are likely to get less and less attractive as the bull market stampedes on. WeWork, whose IPO flamed out spectacularly last year, is now looking at going public via a merger with a SPAC, according to Bloomberg News.
Now consider something more mundane: the return of active fund management. In the 1990s stockpickers who filled their portfolios with tech companies regularly found themselves on the cover of magazines. I can recall going to an art show in Brooklyn and seeing portraits of managers from the Janus funds—a joke of some kind, but one that banked on familiarity. Very few of the stars of that era lasted, because very few stars ever do.
According to the S&P Dow Jones Indices, most U.S. stock funds that ranked in the top half of returns from June 2010 to June 2015 failed to replicate that feat in the following five years. In fact, a fund was more likely to close or change its investment style—likely a sign of defeat—than it was to remain in the top half.
Those long odds persuaded a lot of people to stick to index funds, which tend to beat active managers and have gotten so cheap you have to squint to see the expense ratio. For years this passive money was the main source of asset inflows in the fund industry. Yet now stars are back, this time led by Cathie Wood, who’s invested her Ark exchange-traded funds in Tesla Inc., internet stocks, and even some Bitcoin. You can buy T-shirts with her picture and the words “In Cathie We Trust” on Etsy. Compared with the old days of active-fund dominance, her funds are less expensive—about 0.75% of assets per year—but they’re still many times more costly than indexing can be.
Wood is doing incredibly well, and basically has been since 2017. (Over the past five years her main fund has beaten the mighty S&P 500 by an annualized 40 percentage points.) But in her wake is a new wave of actively managed ETFs, as well as thematic funds, which are technically indexes but are so tailored to their creators’ investment theses that they might as well be active. Who knows which of these funds will prove to be winners in the five years ahead?
Crypto’s rise has benefited from some of the same faddish dynamics. A number of well-known advocates of Bitcoin and other cryptocurrencies have been tweeting their solidarity with the Redditors against Wall Street. That’s a bit rich. Professional money managers going on television to praise the virtues of the Bitcoin they just bought are now a familiar sight. The denizens of WSB are upfront enough to actually say that they’re “pumping” their favorite stocks. On Wall Street this kind of behavior is more politely known as “talking your book.”
Take the complexity of SPACs and multiply that by 100 and you have cryptocurrency markets. Yes, the blockchain means that in some sense everything about Bitcoin is out in the open. But first, enjoy learning what a blockchain is. Go read about Satoshi Nakamoto, Bitcoin mining, the halving, and the forks. Again, there’s plenty of appetite now for learning/overlooking these novel financial concepts. Still, you could spend weeks learning the mechanics and still come away without a satisfying answer to the question: How do you put a value on this thing? And what are the forces driving demand in the cryptocurrency markets—a web of regulated exchanges, offshore trading platforms, and some very murky companies? How much are the ups and downs of Bitcoin the result of manipulation by the big “whale” investors who control the vast majority of the tokens?
In any case, Wall Street is already well embedded in crypto. There are investment trusts offering exposure to it, for a nice fee, and various money managers have tried—so far without success—to get regulators to bless a Bitcoin ETF. That figures, since there are already ETFs for SPACs, and there are brokers selling clients leveraged bets linked to the performance of hot ETFs. It’s boxes inside of boxes in wrappers that make the price tags hard to read.
Robinhood is a different kind of middleman. Unlike a lot of Wall Street, Robinhood doesn’t make its money by standing between you and the market and taking a fee off the top. But it’s still an intermediary—in this case, a psychological intermediary. It’s standing between you and the market with fun software. A Robinhood spokeswoman says they designed their app to make investing “more familiar and less daunting” to encourage people to “take control of their finances.” Startup discount brokerages are similar to media companies now. Like Twitter and YouTube, they need to grab your attention and drive engagement. But their goal isn’t to push ads to you, it’s to get you to trade. Even though they charge you no commission, they do get paid for it.
How? As Annie Massa and Sarah Ponczek recently explained in a Bloomberg Businessweek cover story, Robinhood earns most of its revenue from a common industry practice called payment for order flow. That is, when you buy or sell a stock or an option, they send the order to be executed by an outside trading firm that pays Robinhood. These companies pay because they can earn small profits on the “spreads” between what buyers are willing to pay and what sellers are willing to take for a security. (Robinhood, like all brokers, is required to seek the best possible trade execution for its customers, and it spreads trades among firms.) These little gains add up when trades are done in the millions, and the more trading there is, the better it is for these market makers. They don’t really care if it’s up or down.
So the fight over GameStop was partly just a fight between different parts of the Wall Street establishment. Shorts got squeezed, but some giant high-speed trading firms behind the scenes no doubt did quite well as a result of all the retail trading and volatility. “It’s not David vs. Goliath,” wrote Alexis Goldstein in her Markets Weekly newsletter. “It’s Goliath vs. Goliath, with David as a fig leaf.”
And all along, professionals long and short have been following the signals from retail traders and trying to get ahead of—or stoke—the momentum. Senator Elizabeth Warren, a Democrat from Massachusetts, said on CNN that it’s still unclear what was really moving GameStop’s stock and that there was likely “big money on both sides.” She called for the U.S. Securities and Exchange Commission to investigate possible stock manipulation.
All of this frenetic investment activity might be a cause for optimism if it seemed connected to a healthier economy. But the stock market and asset prices have been inflating and enriching the world’s wealthiest even as most people have faced greater job instability and slow wage growth. So far the sudden enthusiasm for GameStop’s stock hasn’t done much for the company itself, much less for the employees behind the counters. To the traders go the tendies.
A higher share price could be an opportunity to sell more stock and get some cash to reinvest in the company’s business. Some other popular meme stocks, such as American Airlines Group Inc. and AMC Entertainment Holdings Inc., have recently taken steps to sell new shares, Bloomberg has reported, in what are known as at-the-market programs. GameStop may yet try something like that, but it could be tricky to step into a market where shares are $65 one day, $347 a few days later, and $90 a few days after that.
As Henwood, the writer in Jacobin, has pointed out, surprisingly little of what happens in the stock market is about raising money for companies to make real-world productive investments. Prior to the pandemic, corporations seemed short of ideas for what to do with their cash and often forked it over to their shareholders (and their stock-option-paid executives) by buying back their own stock. Perhaps they’ve been looking at financially strained U.S. households and concluded there’s not enough demand to spark growth.
One telling moment in the Battle of GameStop was delivered by veteran hedge fund manager Leon Cooperman in an interview on CNBC. “The reason the market is doing what it’s doing,” he said, “is people are sitting at home getting their checks from the government, basically trading for no commissions and no interest rates.” Lots of people on Wall Street believe the retail trading boom has been fueled by pandemic stimulus and enhanced unemployment checks dropping into Robinhood accounts. Some of that’s happened, no question—there’s plenty of talk on WSB about how to spend the “stimmy.” But more of the money has gone into buying groceries, covering the rent, and paying down debt.
There’s been a lot of cheap money floating around in the past decade, thanks to low interest rates and Federal Reserve policy. Much of that has gone into financial assets, jacking up the wealth of those who own them. Cooperman, to be fair, sees the problem there: “Eighty percent of the stock is owned by 20% of the people,” he said. (The reality is actually more extreme than that, with the richest 10% holding 84% of equity wealth, according to economist Edward Wolff.) No, you can’t day-trade away economic inequality. But one of many changes wrought by the pandemic is that it’s shown how aggressive government spending to put cash in ordinary Americans’ pockets can do a lot of good. What if there was an economy where households relied less on wealth trickling down from asset owners? That would be something for Wall Street to be nervous about.
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