How Does the GameStop Squeeze End?

How Does the GameStop Squeeze End?
Photo: Jeff Roberson, AP

If you’ve been following the WallStreetBets stock squeeze (more info here, here, here), you’ve probably grappled with about 6,000 paragraphs that start something like, “if I gave you one banana…” That’s because you’ve probably learned more about shorts and options and margin calls in a few days than from consuming hundreds of movie and TV stockbroker content. You might have a newfound intimate working knowledge and loathing of online brokerages. Now you know how stocks go up, time to learn about how they go down.

Despite the narrative about a two-party class warfare between WallStreetBets and hedge funds — which has spiraled into mania now on CNBC, where a parade of venture capitalists are suddenly dying to side with “the little guy” — a lot of other people are holding the now-high-priced stocks that WallStreetBets managed to send to Pluto. These include teachers whose pensions are tied up in public funds, individual rich people who’ve gotten richer, and the ailing brick-and-mortar businesses themselves.

Who is most likely to suffer? What happens to the economy, if anything? What happens at the end of a “short squeeze?” We asked authorities in the field for guidance.

Will GameStop and the 12 or so other stocks inflated by retail investors ever go down?

Aswath Damodaran

Professor of Finance at the Stern School of Business at New York University

It is not inevitable but likely. Nothing has changed fundamentally at these companies, and if the only thing holding them afloat is Redditors trading, when they move on to other targets, the stock will lose its oxygen.

Donald Langevoort

Thomas Aquinas Reynolds Professor of Law at Georgetown University Law Centre

We are much too early to be able to provide answers. Nothing is inevitable, but if the past is any indication, the relevant stock prices will revert to mean. What fuels a bubble like this (assuming it is a bubble) is investor overconfidence that past indications that they can move markets indefinitely, which can persist for some time (self-fulfilling prophecy) but does have a natural end point. Obviously, those who got in and out at the right point will celebrate their brilliance, but unless they’re disciplined enough to stop before the reckoning, there will be losses.

Terrance Odean

Rudd Family Foundation Professor of Finance, Haas School of Business, University of California at Berkeley

I have not analysed GameStop’s fundamental value. However, from what I read, I expect that recent prices far exceed fundamentals.

What it probably means is that the prices will drop significantly, though not necessarily all the way to pre-January prices. However, there is no hard fast rule about how fast the drop comes. A stock can stay over priced relative to fundamentals for a long time. Most likely that will leave owners disappointed in future gains, but that can take quite a while. GameStop is unusual because of how much investor attention it has on both sides.

Is there any chance that market makers ultimately take a large share of the losses?

Terrance Odean

Market makers are at risk when they hold large temporary positions in extremely volatile stocks. So, yes, they can take losses. However, the institutional investors at highest risk are those who have large unhedged short positions.

What has happened when major hedge funds, for example, have knowingly inflated a bubble?

Eric So

Sloan Distinguished Professor of Management and an Associate Professor in the Economics, Finance, and Accounting Area of the MIT Sloan School of Management

We saw this during the late 1990s with the Internet bubble. As we know from transcripts and interviews, a number of funds recognised that a bubble existed at the time. But what many realised is that it may be easier to ride the bubble and profit on its upside, exiting before the bubble bursts rather than trying to exert corrective market influence by pushing prices back down to the fundamental values.

Folks who decided to try and chase, and bought at the end of the bubble into the 2000s, ultimately lost. Also one of the undersold groups that lost out as a result of the bubble are hedge funds who tried to exert market influence by pushing prices back to fundamentals. An example are folks like the Jaguar Fund, sometimes known as Tiger Fund, that tried to exert sort of a corrective force moving away from the Internet bubble, taking bets against the valuations. They ended up losing out and ultimately having to close before the bubble burst.

Other funds like Quantum Fund, under George Soros, seemed to hold a position that was more in line with the bubble. I should be clear that I don’t know their intentions, but they survived.

So there was a bit of a disparity in terms of which funds did well than in those that did not. It seems to line up based on those who knew how to ride in time the bubble versus those who tried to exert market influence.

Is there any scenario in which the majority, or even half, of the retail investors who bought GameStop or these other stocks end up with a profit?

Aswath Damodaran


What are the knock-on effects of the GameStop short squeeze to the overall market?

Aswath Damodaran

Hedge funds were already in trouble, coming into this crisis, in terms of performance. Money has been flowing out of active into passive vehicles and this will only accelerate the process. I think Melvin Capital was already losing money on positions, prior to the GME run.

Terrance Odean

Short squeezes in one stock can force funds with large short positions in that stock, to sell other positions often profitable ones in order to raise money to cover margin calls. If a lot of hedge funds have correlated positions and get simultaneous margin calls, this could lead a situation in which these funds all sell the same positions to raise money thus driving down the prices in these positions leading to more margin calls (if the positions are leveraged). Individual hedge funds with heavily leveraged bets could get hurt.

Could this hurt pensioners, like teachers?

Donald Langevoort

[Pension money] is very much going to be a subject of interest — funds must invest prudently, on a portfolio basis, but we know that some public funds feel pressured to make bets inconsistent with that legal mandate. That said, a diversified portfolio is unlikely to suffer much from events like these, and learning from painful experience can be a useful corrective.

What happens to the companies themselves?

Arun Chopra

“Twitter professor” and founder of the financial market research firm Fusion Capital

If you look at AMC — AMC took off, but they’re in deep debt and need money. And so they issued stocks the minute the stock ran, and it’s back down again [at the time of interview]. And so not all short squeezes are equal. This won’t bankrupt the industry.

At the very base level, we see short squeezes happen in markets all the time. We have a strategy that takes all of this into account, and there are three to four really good opportunities every year that will work. That happened in Tesla all the way up. So that’s been going on. It’s a little bit exacerbated now because we’ve never seen this much option trading throughout history.

The real risk is that the short squeeze stocks force these fund managers to start selling their quality stocks. And if that happens, then you’re going to get Google and Facebook and those coming down, and then everything that the Fed is trying to do to keep things afloat will be under pressure. And to me, that issue falls back with the Fed, because why are they letting this get out of hand? And then you could even extrapolate that further back to why this social situation for the class warfare is going on.

Closing thoughts

Arun Chopra

I think what will happen is volatility will remain, and message boards like WallStreetBets will remain. Prior to all this, they were doing research. GameStop was on there for a year, and I’m kicking myself because I wrote it off as a dog.

You can see these fantastical minds on WallStreetBets, especially [the kind of thinking] from people who are younger. When you see things a certain way, and you’re not stuck to dogma and textbooks — this is what creates those boards. There’s no question about those younger people’s abilities.

I think this narrative about the common man comes from everything that’s been going on. We never dealt with this idea that there was a housing crash in the formative years for a large portion of the generation that’s now being asked to pay two hundred grand to go to college, which doesn’t even guarantee anything. I bet that if the system was more fair, half of that group would be busy doing other things.

So when I read posts about living through the housing crisis on WallStreetBets, I think, immediately, absolutely. And I’m shocked watching CNBC, and they’re saying, oh, I like David and Goliath, too! But I’m like, no, you don’t. You’re just showing up, are you kidding?

I just think realism is important, and to understand that this is not going to solve the problem. I’m sure more people lost money on AMC [when it crashed on Thursday] who didn’t even chase GameStop and thought AMC would be the next one. I think the bigger problem we have is that these real systemic issues — like Congress doing something about student loans — need to be addressed.