David vs. Goliath 1:0 - What's really behind the "GameStop" speculation

In one of the biggest hedge fund bailouts since the fall of Long-Term Capital Management ("LTCM", 1998), the firm "Melvin Capital" was saved from ruin this week. The firm had previously speculated on sharply falling prices of various stocks such as Gamestop (selling video games) or AMC Entertainment (cinemas). Both companies had recently suffered greatly from the Corona crisis and the structural trend towards online media, so betting on falling prices seemed lucrative. But the organised resistance of numerous "small investors", organised via the internet platform Reddit, destroyed the hedge fund's strategy within a few days. The investors colluded with each other and drove up the prices of said shares with small purchases each.  Since, for various reasons, more Gamestop shares were sold short than actually existed, the so-called "short squeeze" occurred and Melvin Capital had to cover open positions at dramatically higher prices. In view of the parabolic price development, market observers in this country felt reminded of the price explosion of the VW share in 2008. As a result, the fund suffered heavy losses, which had to be offset by a cash injection of 2.75 billion US dollars from other hedge funds (Citadel, Point72).

The spreading price speculation around shares like GameStop, AMC Entertainment, Nokia or here in Germany Varta is based on a coordinated action of private investors against hedge fund managers and analyst boutiques betting on falling prices. The anger of the small investors, who are mainly based in the USA, runs deep. Many of the investors are clients of the online broker "Robin Hood", which in turn has become known for regularly selling on its clients' orders as a flow of liquidity to the hedge fund firms already mentioned. In addition, although the financial industry in general (including analysts, by the way) has been increasingly put in its place by regulation, some quite questionable "short sellers" or hedge fund managers who bet on falling prices are still allowed to spread their horror scenarios in the media. In addition, in the USA, unlike the large hedge funds, "normal" clients rarely have access to the allocation of lucrative new issues.

"Pump and dump" or "scalping" of smaller stock titles on message boards or social media channels is as old as the internet itself. And before the internet, it was stock market hotlines and cold calling. This time, however, things are different. Until now, it was mostly lone perpetrators (as excellently portrayed in the film "Wolf of Wall Street") who manipulated events. This time, however, the "crowd" wants to make common cause against the big Wall Street addresses. This again brings a term into play that many market participants already know from the Bitcoin world: The keyword is "DeFi", the abbreviation for "Decentralised Financial Markets". The core of this theory is the assumption that established (centralised) price formation processes, such as in IPOs or on stock exchanges, must take a back seat to new, decentralised platforms in the long run. In the world of cryptocurrencies, this development has been observable for some time. Will it also take place on the stock markets? So far, this is not foreseeable. But much depends on how US brokers, exchanges and regulators will react to this week's developments.

The next few days could remain choppy in the markets, as the current speculation already caused the highest turnover in stocks on the US exchanges since 2008 yesterday. Until the current turmoil subsides, volatility is likely to remain elevated, at least in small- and mid-cap stocks. However, large-cap stocks on both sides of the Atlantic should not be dragged into the wake of volatility in smaller stocks. Once again, it appears that most investors are better served by staying away from trading in stocks of bankruptcy candidates, options or even speculating on credit. For investors betting on long-term rising prices, there is no need for action. They should stoically continue to pursue their strategies.

-- Christian Kahler

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