Erik Oros examines the GameStop short squeeze, brokerage liquidity pressures, speculative valuations, and the disconnect between earnings and equity prices.
From the original report
Selected passages from the original publication. Historical observations reflect the report's publication date, not current market advice.
We begin our first letter in 2021 amidst a historic moment in global markets. While analysts prepare for earnings reports for over 30% of the S&P market cap in the final week of the month, Wall Street is instead besotted by an incredible short squeeze of epic proportions. Perhaps the poster child of this phenomena, GameStop, has seen its shares rise well over 1000% in 10 short trading days. Other stocks touted on the popular “Wall Street Bets” Reddit group such as AMC have seen their shares surge in recent days. The movie theater operator whose business remains undoubtedly challenged is currently valued at multiples of is value before the pandemic struck. Throw the textbook out the window it seems.
The effects of this short squeeze and improbable distortions of value have limited effects on the overall market and the economy. However, this clear break down in the sacred pricing mechanism of capital markets is emblematic of the liquidity induced behavior that has driven valuation multiples to nose-bleed levels. Many have pointed to this behavior as a triumph of small investors. Unfortunately, rampant speculation of this scale might be the clearest indication to date that global markets sit on shoddy footing.
Perhaps most concerning is the eroding of public confidence in markets, custodians, brokers and the system that governs efficient markets, combined with a regulatory authority that shows little concern with the consequences. When asked at the January FOMC press conference about the concern around the potential bubbles being formed in markets, Chairman Powell shrugged off concern as “not my/our responsibility.” Further, the public uproar over the restrictive trading measures that brokers were forced to enact around this bonanza has led to ill-founded and dangerous conspiracy theories. Widely accepted is the narrative that the reason for the restrictions was to benefit the Wall-Street establishment, hedge- funds, and powers that be that are at reeling in losses. In fact, it is likely that these restrictions are a dangerous indication of the strain on liquidity being faced by such brokerage firms. New investors might be forgetting that above all liquidity and solvency of their custodian is paramount and not a given. Potential spill overs from a failure of such brokerage firms could be catastrophic to the market.
For educational purposes only; not individualized investment, tax, or legal advice. Investing involves risk, including loss of principal.
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