In January 2021, the share price of GameStop (the parent company of video game distributor Micromania) was the subject of massive speculation by individual shareholders. The share price was multiplied by 24, rising from $20 to $482 per share (on 28 January at mid-session) in just a few days. Its valuation reached €20bn and then fell back to around €3.5bn. Several hedge funds betting on the fall in prices had to hedge their positions and suffered losses of several billion dollars (Melvin Capital, Citron Research). This unprecedented movement originated on the Reddit community website and its Wallstreetbets forum where several million people met to discuss the GameStop company.
Several hedge funds suffered massive losses on GameStop. Did individual shareholders win against hedge funds as some claim?
Not at all! Many small holders arrived on the scene towards the end of the speculative movement and suffered considerable losses. We can see it for their communications on social networks. They are quick to mention their counter-performances – sometimes with sums of several tens of thousands of dollars – in a heroic way. This is the political dimension of GameStop.
How do you explain this phenomenon?
There are three key elements. The first is the abundance of cash, particularly from US federal government cheques following the Covid-19 crisis. The second is a combination, perhaps a lasting one, of two technical elements: the development of free online brokerage applications, such as Robinhood, and the use of social networks favouring the coalition of a host of individual speculators. Finally, the third is political. Some leaders wanted to replay an old American battle, Main Street versus Wall Street. In other words, smallholder citizens versus big hedge funds.
But this political explanation actually clashes with reality. It was rather a question of many individuals who had cash, free time and thought they could make money quickly joined the movement. By betting on an action, regardless of the fundamental value of the company, they eventually adopted the speculative practices of those they claim to fight. One of the first leaders of the movement was sincerely convinced that GameStop was undervalued and had been saying it for years, but he was overwhelmed by a runaway effect in which we even saw Elon Musk encouraging buying on Twitter against the backdrop of an anti-establishment culture!
Does this reverse the balance of power between funds and small investors?
Some funds have lost billions and will probably be more careful in the future. But that doesn’t change the fundamentals. The debacle confirms a great law of speculation: firstly, to win you need to have “deep pockets” and be able to withstand brutal fluctuations; secondly, you need time to be able to hold your position and not be swept away by those movements, and finally you need quality information, often in the form of very thorough analyses. Many small carriers had very little information and did not care about the fundamentals. This pseudo defeat inflicted on hedge funds by small investors is probably more a flash in the pan than a real victory.
Can it happen again?
Of course it can. Other cases, such as AMC (a US cinema chain), have been mentioned on these forums, but the success of novice speculators is on the whole not very conclusive. As always, a few win, but the vast majority lose. The stock exchange is not a casino, it is first and foremost a mechanism for financing the economy.
What can we do to protect our economy from these excesses?
It works both ways. There are vulture funds that take advantage of the markets, are never sanctioned and are saved in case of crisis. This was one of the major criticisms of Main Street against Wall Street after the financial crisis of 2008. But we must also look at the other side of the mirror: brokerage platforms that allow entry and exit without minimum guarantees or friction create considerable volatility that can lead individual shareholders to commit stupidities and end up ruined.
GameStop’s share price plunged back down again when the Robinhood platform tightened trading conditions and as such considerably limited the purchase of shares. This is a regulatory issue under discussion in the United States. We must therefore succeed in both curbing the hordes of private speculators who hijack the vocation of a stock exchange and introduce mechanisms that prevent certain activist funds from dismembering companies in a frighteningly short term. At the heart of the GameStop affair, the issue of short selling (selling securities you don’t have by speculating on their decline) is one of the key technical points to be resolved. There is no easy answer, and the debate is taking place in many countries, including France.
What is the usefulness of hedge funds?
There are two ways of looking at it. The first is to consider that they are raptors who play on price variations, which they provoke or amplify by shaking up the markets, in order to get rich quickly at the expense of the real economy. The second is to consider that they have a real disciplinary virtue in classic shareholder governance. They do in-depth work on certain companies, dissect their accounts and strategies, and identify real weaknesses, going so far as to mobilise all sorts of means (law firms, economic intelligence companies…) to obtain critical information, then use communication agencies to mobilise the press and rally other shareholders to their theses.
Even if they hold only a small share of the capital, their attacks end up destabilising the management in place and influencing their strategy, or even provoking their replacement. Whilst they are not appreciated, the user of these activist funds are hard workers, often highly qualified, who collect high-quality data and do not let go of their prey easily. This function of market “discipline” can also make sense against incompetent managers or those who are abusing their position. There are many examples of companies whose weaknesses have been brought to light by these players. Recently in France, for example, the complex financial arrangements of the Casino group, raised real questions. Another is the German Wirecard fintech, valued at up to €17bn in Frankfurt, which has deceived the German financial regulator for years with widely distorted accounts. It has since collapsed as a result of this deception, notably thanks to investigative work and pressure from certain funds.
Should short-selling be regulated?
Yes, it must be better controlled to bring transparency and clean up certain issues (securities lending, settlement/delivery, deadlines etc.). The objective is to maintain the financial, managerial and economic discipline that activist funds, like other shareholders, bring by limiting pure speculation. A company can have a moment of fragility or weakened management without justifying attacks that are globally destructive of value.
Interview by Clément Boulle