Running the thought process through the Gamestop insanity

A bunch of scattered thoughts in this post.

In more traditional times, you gave some company money, and they would issue you shares which represents a claim on their residual earnings. These companies would take your money, and invest it in machines, infrastructure or people that would produce goods and/or services that were in demand and would make money from it, taking in more cash than they spent. With the help of your investment money, they would build up surplus cash which they’d either dump back into the business (if they could generate more of a return on it) or if the market has been saturated, issue the capital back to you in the form of a dividend. While there was no set rate of return (it was highly variable, depending on cost of capital, risk of the business, etc.), generally speaking if you made a 15%/year return on investment it was considered greatly successful since the alternate, risk-free government bonds, would give you about 5%/year. The spread between the yield on debt vs. equity was a premium that an investor would demand in exchange for the increased risk of holding the equity instead of the debt.

Later, you had people buying stock from other people instead of from the companies directly. Their shares would trade on an implied return on investment, which would be comparable to the above.

Fast forward to 2020. Risk-free rates have gone to near-zero – you can’t put money into government debt and make any sort of return anymore. Asset prices have risen, so companies that have gotten a 15% return on their investments are now trading at 5% (indeed, looking at Microsoft/Apple today, that is closer to 3% on their equity at present). From an aggregate perspective, you can’t get rich quickly anymore. While 15%/year might be acceptable in older times, now, not only can you not make that with conventional investment (in the aggregate market) but at the current rates of return, it’ll take forever to double your money. What’s the point?

So hence we have money being thrown into all sorts of speculative vehicles. Just a couple months ago, Bitcoin was the big thing, where people were clearly talking about the “next currency” being a “store of value” and “they don’t print any more bitcoins”, yada yada yada. Because the organic return on Bitcoin is zero (indeed, you can make a claim that the aggregate return on Bitcoin is negative because of the electricity consumption required to maintain the network), there are no valuation metrics to constrain what is essentially narrative thinking. When you see media pick up on the notion that central banks are “printing money” (not strictly true, although their actions are completely involved in the low rates of return we see), people buy into the narrative that fuels this rampant speculation. Instead of making 15% a year, you can make that in a day!

Then we fast forward to Gamespot, AMC, and the like. Rationally, Gamespot is running a dead business, like Radioshack or Blockbuster of the past. But sensing a quick opportunity, hedge funds bidded the crap out of it and forced a presumptive wealth transfer.

The thing to always remember is that Bitcoin, Gamespot, and the like, all represents a zero sum game in the short term. There are no returns to be made other than off the capital of other market participants. GME, AMC, etc., are trading off of their value to be short squeezed, coupled with a bunch of retail sentiment that wants to gamble to get a quick return on their investment. After all, when Gamespot goes up 150% in a day, that’s a heck of a better reward than doing it the old fashioned way and spending a year to get your 5%!

For these hedge funds that were heavily short, however, it will be a catastrophic event. This will have ripple effects on the market, including prime brokers likely raising margin requirements for heavily shorted stocks, in addition to the long sides of their portfolios being culled down. This will be a forced sale process, which means it will come with volatility. This will most certainly be the first blowup after the COVID crisis, although this one will be short lived.

There will be a ton of money made by some people, and a ton of money lost. It will be irresistible to most retail participants that see this and feel like they want a slice of the action. Some indeed will do very well. While entertaining to watch, my focus is kept elsewhere.