Will GameStop episode put an end to the market rally?

The episode, which has turned out to be an epic battle between retail investors and the Wall Street, can even result in hedge funds booking billions of dollars of losses, leading to a market crash

Staff Writer   /   January 31, 2021
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By now, you must have heard about ‘GameStop’. The US-based video games retailer has been in news globally after its stock went from less than 3 dollars to 325 dollars (at present) in less than a few months. The stock has appreciated over 1600% in January alone. But that is not the main reason why $GME has become a global sensation. Continuous short squeezes in GameStop, due to the coordinated buying by an army of retail investors, has put the stock on the global map.

The fight is being billed as modern class war, and the small guys are winning! In the process, short-sellers, including giant hedge funds, were caught in a tsunami of losses running into billions. Here is a low down on the GameStop saga and the takeaways for Indian investors. 

What is GameStop

GameStop Corp. is an omni-channel retailer, offering games and entertainment products in its over 4,000 stores and comprehensive e-Commerce properties across 10 countries. It sells new and pre-owned video gaming consoles, accessories and video game titles, in both physical and digital formats. It also makes some money from toys, collectibles etc. 

How is GameStop doing as a company

With the Covid induced problems in the economy, the shift from offline to online and lower consumer spending, the company has been slipping. It reported a Q3 adjusted operating loss of $62 million on a 30% drop in revenue of $1billion. The company has close to $500 million in debt. It has closed more than 800 stores since 2019.

What exactly happened with GameStop shares 

GameStop shares have risen from a 52-week low of $2.57 a piece to a 52-week high of over $400. The stock is trading at $325 levels now. That’s a massive gain and in an incredibly short time. 

Essentially, many small investors made a huge bet against gigantic financial institutions. And, the small guys are currently winning that game. The episode has been viewed as one of the largest wealth transfers from the financial ruling class to the middle and middle-upper classes. 

How can small investors win against big investors

The members of a discussion group called wallstreetbets in Reddit (a social media platform) analyzed the GameStop stock and concluded that its price was undervalued. Then, they identified a weakness in the strategies of several giant hedge funds, who had bet millions of dollars that GameStop stock would fail. 

What was the modus operandi

These Redditors (Reddit users) bought huge numbers of GameStop stock at low prices, held them and even kept buying more as the prices rose. This has led to a giant short squeeze, which is again driving the price of GameStop up but emptying the coffers of these hedge funds in the process such as Melvin Capital. 

Why were Wall Street hedge funds hit

Hedge funds bet GameStop’s stock will become less valuable. So, they sold shares that they do not own. It’s done by locking the stock price at a higher price in the belief that sometime in the near future the price of that stock will go down. When that happens, short sellers buy the stock at lower price and close the deal. 

In the case of GameStop, short sellers actually lost. They bet the stock price would go down, but Redditors ensured $GME goes up instead. With stock prices going up, short sellers were left waiting for a price crash to cover their positions. But that crash never happened. The problem was compounded because short sellers apparently shorted more shares of GameStop than actually exist! 

Can a GameStop saga happen in India

Yes and No. Shorts are squeezed daily, but in India the quantum may not be as high as that of GameStop. Market regulator SEBI and the exchanges have many curbs in place to restrict uncontrolled risk-taking. In the cash segment, naked short selling (selling without owning shares) is banned in India. If the transaction is a short-sale, then investors have to deliver the shares of the shorted securities during settlement. 

Plus, exchanges also impose circuit filters on stocks that stop their daily price swings at 2 to 20%. In the case of GameStop, due to the lack of stock price limit, the US based company shares rose more than 100% on some days.

The impact on global markets

The Wall Street has corrected sharply in the last two days, mainly on account of the GameStop short squeeze news. In case large hedge funds end up losing big money – or they may even go bankrupt – if the GameStop stock continue to go up, then the broader market is going to take a hit. Then the question is will this be the beginning of a larger market crash from hereon?

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