Does GameStop's Soaring Stock Indicate A Possible Market Bubble?
(CBS Detroit) -- The stock market has appeared to be acting a little crazy for much of the last year. The Dow Jones, S&P 500 and NASDAQ have all grown steadily, despite the COVID pandemic and resulting economic crisis. The simple explanation is that the extended rise reflects the market's optimism in a more stable future. A more complicated explanation, given the ongoing GameStop saga, suggests that maybe there's more going on.
After bottoming out in March, the stock market has enjoyed a steady rise through earlier this week. The Dow Jones, for example, climbed out of a sub-19,000 hole last spring, passed the 30,000 milestone before Thanksgiving and remained around 31,000 for much of January. The Dow actually suffered its biggest drop in three months yesterday, however. The S&P 500 and NASDAQ have followed similar trajectories.
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Investors value stability. But that time frame was marked by anything but. A runaway virus killed over 420,000 people. The vaccine rollout fell well short of the levels promised. Record unemployment, that neared 15 percent in April, still remained far above pre-pandemic figures. An ugly and divisive presidential election led to a disputed result and a testy transition. And, most recently, a mob of insurrectionists invaded the Capitol looking to keep the losing candidate in power.
Rising stock values in the face of so much turmoil doesn't make sense on its face. But the last 10 months have also seen two highly effective vaccines become available. Multiple stimulus packages have helped pump money into an economy buoyed by low interest rates and a Fed willing to backstop everything. With Democrats in control of the executive and legislative branches, another stimulus package seems inevitable in the near future. In other words, there's an end to the pandemic in sight, and an economic bridge is being build to get us there.
While the stock market pays attention to the news, it reacts based on how it will be affected six to 12 months in the future. And at any point after the early days of the pandemic, evidence for a brighter tomorrow could be found.
But maybe there's an additional reason why the stock market finds itself enjoying historic gains during these troubling times. High levels of unemployment have not affected all income brackets equally. The jobless rate among low-wage workers is still around 20 percent, while most higher-wage workers have kept their jobs.
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According to David Kass, clinical professor of finance at the Robert H. Smith School of Business at the University of Maryland, "because people were at home, they were unable to spend the money on travel, tourism, entertainment, going to concerts, etc. The money effectively went into savings. You can't spend it the way you normally would. And a lot of the savings went into investments. With interest rates being kept close to zero by the Federal Reserve, any investor trying to earn a positive rate of return, as virtually all investors will, what's your next best alternative to a bank savings account or CD or Treasury note? And, of course, the best alternative, a very readily accessible alternative, is the stock market, investing in the market."
"Many millennials, younger investors, opened accounts, for example, through Robinhood and other brokerage firms, which, in turn, actually around the same time, stopped charging commissions or fees to trade in the stock market," Kass continued. "So basically a frictionless system, encouraging investment. So a lot of the money that couldn't be spent in the economy, because a lot of it was shut down, temporarily, would be reallocated to investment in the stock market."
These individual investors are increasingly optimistic that stocks will continue rising and are investing accordingly. As noted in a recent New York Times article, that enthusiasm is starting affect the market in general. Options trading, which has become popular among small-time traders, is one example.
The stock options market lets people speculate whether a stock will go up or down. Those who think a stock's price will go up by a certain day can lock in a lower price now by purchasing what's known as a call option. Up until that day, they can then buy the stock and sell it for a profit.
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The brokerage firm that sold the contract must cover itself, so they buy some amount of the stock they may eventually have to sell. Rising prices lead to more stock purchases, which lead to rising prices. The upward trajectory of that stock results from how the options market works, rather than the underlying strength of the company that issued the stock. This chain of events spread across the broader stock market can create a bubble.
Unbridled optimism seems to be pushing up the share price of one stock in particular -- GameStop. The beleaguered retailer had seen its price flounder, with a customer base increasingly inclined to download video games rather than buy the physical version. The company's share price ended August below seven dollars and began 2021 at $17.25. It ended trading Wednesday at $345.00.
Professional investors had been shorting GameStop stock for awhile. In other words, they've been selling shares of the company in advance of owning them. The thinking is they can buy the shares later, when the price has dropped, and make a profit. It's generally a risky approach to investing. But betting that the price of GameStop would go down, given the company's future prospects, had paid off nicely. The stock fell for six consecutive years before last year. Lately the price has been soaring thanks to small investors banding together to buy and hold more and more shares.
The short-sellers, which included many hedge funds, are taking a bath. They have to now buy the stocks at a higher price to make good on their position. And fewer shares are available. That pushes the price even higher. It's commonly called a "short squeeze."
Part of this turn of events can be seen as revenge. Short-sellers are somewhat unpopular among investors, and sticking it to them can be a point of pride. Some credit also goes to the growing confidence of the masses to effect change. Whether that confidence is warranted remains to be seen. But day-trading, whether to exact revenge or profit in the short-term, comes with a fair bit of risk.
Claims about "the stock's intrinsic value and GameStop's importance to the gaming industry," as Bloomberg put it, only go so far. How long can a bunch of small investors prop up a failing company? GameStop closed hundreds of stores last year and lost $1.6 billion over the last three years. (Keep in mind that everyone has been stuck inside since last March and in need of entertainment.) The company isn't likely to turn a profit until 2023. And even that timeline is uncertain, given that video game stores seem destined to follow record stores into the past.
With GameStop stock's recent volatility, the price isn't likely to remain high for long. A large-scale selloff from investors looking to lock in unforeseen profits could bring it crashing back down to earth. GameStop executives could be among them, and they'll be handsomely rewarded for driving a company into the ground. Regardless, someone is going to be left holding the bag when the share price drops. And that could very well be the casual, optimistic investor, who may not appreciate that what goes up, often comes down.
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