SHARES IN GAMESTOP, an American video-game retailer, resumed their wild ride on January 29th, after some brokers removed restrictions on trading in the stock. When the market closed, the shares were priced at $325—up by 68% on the day and a long way from the $20 they were fetching back on January 12th.
The saga, which has appeared to pit retail investors against the titans of Wall Street, has drawn regulators’ attention. The Securities and Exchange Commission (SEC) warned that “extreme stock price volatility has the potential to expose investors to rapid and severe losses and undermine market confidence”, and said that “we will act to protect retail investors when the facts demonstrate abusive or manipulative trading activity that is prohibited by the federal securities laws.”
The commission also said it would “closely review actions taken by regulated entities that may disadvantage investors or otherwise unduly inhibit their ability to trade certain securities.” That appears to be a reference to the recent trading restrictions (the SEC did not return emails or calls for comment). Those rule changes also prompted sharp comment from politicians including Alexandria Ocasio-Cortez, a Democratic congresswoman from New York, who called the restrictions “unacceptable”.
But Robinhood, one of the most popular trading sites, raised $1bn on January 28th to help it remove the restrictions. Vlad Tenev, its chief executive, told CNBC that “by drawing on our credit lines, which we do all the time as part of normal day-to-day operations, we get more capital that we can deposit with the clearing-houses and that will allow us to enable ideally more investing with fewer restrictions”. This capital-raising appears to stem from the regulations imposed after the financial crisis of 2007-09, particularly the Dodd-Frank Act, to try to reduce the systemic impact of financial speculation—rules that you might expect Ms Ocasio-Cortez to support.
The more pressing regulatory issue may be the risks involved in retail investors piling into individual stocks, particularly through financial instruments such as options, which are high-risk. The incident sparked memories of the “radio pool” of the 1920s when investors drove up the price of RCA, an electronics company, and then pulled out, leaving retail investors holding a falling stock.
GameStop seems an unlikely stockmarket star. In the five years to January 31st 2020, its share price fell by 85%, while the S&P 500 index rose by 79%. Its sales were down by 28% over that period and the losses from continuing operations in the two most recent years came to around $1.3bn. The company launched a “multi-year transformation initiative” in May 2019 that involved a switch into e-commerce, but the pandemic added another problem; in the third quarter of 2020 its net sales declined by 30%, year on year.
So bad were the company’s prospects that short-sellers had taken aggressive positions, betting the share price would fall further. That allowed retail investors to impose a “short squeeze”, in which a rapidly rising price forced the bears to cut their positions. Whether this is really a victory over Wall Street is another matter; some hedge funds may have bought into the surge, after all. And the short-sellers are often loathed by the real Wall Street titans. Dick Fuld of Lehman Brothers once declared: “When I find a short-seller, I want to tear his heart out and eat it before his eyes while he’s still alive.”
The short squeezes are not confined to GameStop. Some of the biggest share price gains this year have been made by companies that were the most heavily shorted and those with the weakest balance-sheets. That seems an uncomfortable result for those who believe markets are always efficient, and allocate capital to the companies with the best prospects.