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Gambling vs. Investing

Last week, the financial media took a brief break from its annual preoccupation with predicting everything that will happen in 2021 (usually inaccurately). Instead they brought us the engaging story of how masses of small amateur investors managed to bid up the share prices of three largely-unprofitable companies. GameStop, AMC Entertainment Holdings and Blackberry were up nearly 1,000 percent collectively. GameStop alone rose more than 1430%—surely some kind of record for a firm whose market share is eroding and which most analysts think is clinging to an outmoded business model. (As you may know, the company sells video games through bricks-and-mortar retail outlets in a world where everything can be downloaded.)

The story was about David (the small investors) pitted against Goliath (several prominent multi-billion-dollar hedge funds), and the only reason you heard about it is because the small investors won and nearly put the hedge funds out of business.

Market professionals recognize the story as a classic short squeeze: investors on one side (in this case the hedge funds) borrow the stock of companies they think are overpriced, expecting to buy them at a discount after the fall, allowing them to pocket a quick profit. These short sales have their own rules, and often if the stocks unexpectedly rise in price, the short-sellers scramble to buy the stock at higher prices to limit their losses. On the other side of the gaming table were a group of amateur investors who engage in online conversations on reddit, who were determined to raise each other’s bids. When the hedge funds were forced to buy to close out their positions by buying more stock to cover what they borrowed, the share prices went through the roof. The hedge funds, meanwhile, lost an estimated $5 billion on their bets; roughly $1.6 billion on January 29, when GameStop’s stock jumped 51%. 

What the financial media neglected to mention is that this activity is not investing; it is a form of gambling. This story tells us a great deal about the mindset of many retail investors these days. When their goal is to make bets, and destroy other gamblers at the table, the situation for everybody else becomes increasingly dangerous, even the long-term investors. Take a look at the past 6 months of GameStop’s stock price and see if you can pinpoint when the gamblers started taking an interest.

Toward the end of every bull market cycle, there is an invisible line that is crossed when the public starts to think of the stock market, not as a way to share in the growth and profits of public enterprises, but as some kind of roulette wheel where the ball always seems to stop on a higher price. These share owners cease to be long-term investors, and prices are bid up not based on the underlying value of the companies, but on the expectation that whatever you buy, at whatever price, someone else will come along and pay a higher price.

Of course, markets only work that way for a short time, typically at or around market tops. Eventually, the share prices of GameStop, AMC Entertainment Holdings and Blackberry—and perhaps many other stocks that are being gambled with at the moment—will return to something that more closely resembles the real value of the real company. Long-term investors have tended to win the kitty over every past historical time period, while gamblers often see their short-term winnings evaporate in the ensuing market declines. The jubilant traders on subreddit r/wallstreetbets (bets, indeed!) can enjoy their winnings today, but it may not be long before many are counting their losses and wishing they hadn’t gambled away the money that could be used to buy shares when they finally go on sale.

The bottom line is that we remain concerned about the markets in the short term, but believe that we are headed for a true economic recovery in the intermediate and longer term. We will be buyers periodically, and even more so on market pullbacks.

As always, please feel free to contact us with any questions or concerns.