Low yields on traditional sources of income are just one of the effects — a necessary evil — of very accommodative monetary policy. Another effect is market speculation, which was top of mind for investors in early 2021 given what happened with GameStop.
So what happened?
GameStop was experiencing challenges given its “Old Economy” business model – operating video game stores typically located within shopping malls. But for more than a year, a small but devoted group of investors bought GameStop stock and call options and talked it up on social media sites such as Reddit. This caused its fan base – and retail investor base – to grow. Excitement also built around other stocks currently facing headwinds, such as AMC, Blackberry, and others.
Then, these investors noticed that many hedge funds had shorted GameStop’s stock — meaning that their positions would profit if the stock price fell. This is a common tactic in the hedge fund world for turning profits; however, it can backfire if the stock price goes up. Small investors spread the word over social media, bought up GameStop stock, and pushed the stock price higher in order to create a “short squeeze” on hedge funds. In other words, these hedge funds were compelled to buy the stock in order to cover their short positions before their losses grew further, and that added buying activity compounded the stock’s meteoric rise.
Small investors drove up GameStop from a market capitalization of less than $1 billion in the summer of 2020 to more than $22 billion by early 2021 (1). Because of the volatility in GameStop and other stocks, some trading platforms limited retail traders’ ability to trade, a move that was very controversial. Volatility in the overall stock market in early 2021 was partially blamed on the speculative behavior involving these stocks.
Is further volatility ahead?
There is concern that the level of speculation in markets could create more volatility and instability, and suggests that markets are frothy. After all, it’s not just a handful of stocks with challenging business models that have been bid up dramatically — it’s also cryptocurrencies such as bitcoin. We need to recognize that extremely accommodative monetary policy can often create unintended consequences such as froth and speculation in some small corners of the investing universe. It’s happened before and it is likely to happen again.
We have to keep in mind that in general, stock market fundamentals are solid. Earnings season has been good thus far with 82% of S&P 500 Index companies that have reported delivering a positive earnings per share surprise, and 76% that have reported delivering a positive revenue surprise (2). In my view, investors should not get distracted from focusing on their financial goals by worrying about what is going on in small portions of the investing universe, even if at times it can create broader volatility.
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