Nearly 25 years ago, then Federal Reserve Chairman Alan Greenspan asked, “How do we know when irrational exuberance has unduly escalated asset values, which then become subject to unexpected and prolonged contractions?” Given the recent volatile action of GameStop stock, I wonder: Is irrational exuberance back?
GameStop, the brick-and-mortar video game seller that many presumed was destined to the dustbin of retailers, started to attract enormous interest from individual investors on Reddit—a message board where community members create content, submit links and comment on specific topics (subreddits).
The active traders on the subreddit Wall Street Bets recall the day traders of the dot-com boom and bust. There are some similarities, as the pandemic recession has allowed many of the lucky employed to have the time and money to dip their toes into various assets. But today, better technology, zero-cost trading and the social media megaphone has made it even easier to jump on an investment bandwagon.
The GameStop believers touted the upside as early as mid-2019, after Michael Burry (the guy in “The Big Short,” who bet against the housing market in the mid-2000s) had amassed a big position in the company, when it was trading in the single digits. Last fall, the bandwagon got even bigger after Chewy.com co-founder Ryan Cohen amassed a 12 percent stake and joined the board.
As the stock marched toward $20, it was bad news for short sellers, who believed the stock was overvalued, amid a climate of shrinking retail footprints. For the uninitiated, short selling means that an investor borrows stock from an investment company and then sells it in the market. If price drops, the short seller can repurchase it and send the shares back to the lending company, pocketing the difference. If the price of the stock rises, the short seller faces losses.
Short sellers often get a bad rap and are seen as the villains of the financial markets. “There is a natural tendency to feel that short selling is somehow inherently malevolent or un-American. To the contrary, it is quite positive for our economy to correct overpricing and detect fraud,” said Yale Professor Owen A. Lamont, when he testified as before the Senate Judiciary Committee in 2006.
It was short sellers like James Chanos who uncovered the massive accounting fraud at energy giant Enron. Chanos has pointed out that the bets “against” companies are not whimsical; rather, “short sellers ask the tough questions and dig out the discrepancies in the financial statements and other regulatory filings made by publicly traded companies.” Similarly, Michael Burry did the hard work when he made his unpopular big bet against the housing bubble.
In the past, short sellers’ biggest threat was the targeted company itself. Corporate boards would issue disparaging statements about short sellers; attempt to strong arm them with legal or regulatory action; and even resorted to technical measures to prevent them from being able to borrow shares to sell.
The hedge funds that bet against GameStop ran into a very different threat: that of a loosely organized social investor movement, which urged small investors to band together and to “squeeze the shorts.” A short squeeze occurs when there is enough buying in a stock that shorts start losing on their bets, throw in the towel and then start covering their own losses by purchasing shares themselves. GameStop may prove to be the mother of all short squeezes and a surefire case of irrational exuberance, as the stock price soared by 10 times in a week.
Those who are investing in volatile stocks like GameStop should be prepared for a wild ride and should only risk what they can afford to lose.
Jill Schlesinger, CFP, is a CBS News business analyst. A former options trader and CIO of an investment advisory firm, she welcomes comments and questions at askjill@jillonmoney.com.