Stocks fell sharply on Friday as speculation amid stocks of companies caught in a short squeeze escalated once again. Lost in the noise surrounding GameStop was news that GDP grew 4% in the fourth quarter, while the savings rate surged to over 13%. The economy is doing fine.
Indeed, the message this morning starts with the economy. Recovery from the brief recession caused by the Covid-19 imposed quarantine last spring continued in Q4, even while Congress delayed passage of another Covid-19 relief bill until early this year. The Federal Reserve continued to pump money into the economy, more than $5 billion per day. Ideally, that money would prime spending and business investment. By artificially keeping rates near zero, below zero in real terms, the Fed has prodded consumers and investors to spend. But in weak economic times caused by a pandemic, and with unemployment rates still extremely elevated, Americans didn’t want to spend. They didn’t want to spend because they were nervous about the future. They didn’t want to spend because governments restricted their activities. No Sunday tailgates. No plane rides to see friends and family. No fancy vacations. No weddings or charity affairs. No need to buy expensive clothes if you live all day in exercise clothes.
So what did everyone do with the money piling up? They invested it. Initially, stocks staged a strong rally led by the tech leadership names. As prices rose, cautious investors felt more secure. Instead of just buying Apple# and friends, they became more emboldened. They bought Tesla, Zoom, Peloton, and a lot of fancy semiconductor stocks, which in turned soared. The Fed kept feeding the rally. $5+ billion per day. It wasn’t just stocks. By Fall, home prices started to rise as Americans emerged from quarantine-imposed cocoons. Oil, which traded near $0 in March was back above $40. Caution was turning to speculation.
By late Fall, new issues were coming public at double their offering price. Names like Airbnb and DoorDash were instant home runs. They doubled on Day One and sold at 20, 30 or more times revenue. Euphoria was setting in. Not everywhere, but certainly on the speculative fringes. And the Fed kept feeding in $5+ billion per day.
It didn’t end there. As the calendar moved into a new year, SPACs became a new acronym that grabbed investor attention. These blind pools could buy anything associated with hot topics like electric vehicles, data analytics or whatnot, and watch stocks surge 100%+ when the deal was announced. Many of these companies not only have no earnings, they have no sales. Some may never have any sales.
Bitcoin popped to $40,000, the same Bitcoin that not long ago traded at $4,000. Its intrinsic value remains the same. Near zero.
Still, the Fed kept pumping $5+ billion per day. Money velocity was at record lows. This new money wasn’t being spent. Or at least most of it wasn’t being spent. GDP, as mentioned, has resumed growth, but the savings rate of over 13% tells us that a lot of that money in simply going to cash. Some of that cash went toward a new home. Or an IPO. Or a SPAC.
Fast forward to last week. The short squeeze. Big investors had placed large bets that companies like GameStop and AMC could not sustain life even after getting injections of new money and new management. GameStop was to video games what Blockbuster was to movies. We all know how that ended. AMC has a huge chain of empty movie theatres. Some may never reopen. Attendance may never regain pre-pandemic levels.
But shorting is dangerous as we noted last week. The downside can be limitless. Fundamentals don’t matter during a short squeeze. As losses pile up, the custodians and lenders of borrowed shares demand protection. The investor caught in the short squeeze either has to come up with more money or cave and a cover at a large loss. While this was portrayed as the insurrection of the little guy at the expense of the big hedge fund, the headline betrays the reality. $30 billion of GameStop stock alone traded on Friday. This doesn’t count the value of options traded. That’s just one stock. This has escalated to far more than a few smart geeks with a Reddit account and avid followers of WallStreetBets.
And the Fed keeps feeding in $5+ billion per day.
The government says it is watching. Congress, never wanting to miss an opportunity to weigh in, says it will hold hearings. The Fed simply shrugs all this off. It denies any complicity in all these bubbles.
They aren’t going to end. This morning, the GameStops of the world remain enormously volatile. But now they are joined by others. The silver miners are now in focus and they are popping. Why silver and not gold? It’s the little guy’s gold.
Ultimately, GameStop shares will sell at their economic value, the price that reflects the present value of future earnings. Did you see the long lines at GameStop stores over the weekend? Neither did I. Fundamentally, nothing has changed. No one went to a movie at an AMC theater either. We all know how this is going to end. We have seen this play out too many times before. A share of GameStop is today’s equivalent of a Dutch tulip, worth something, but nowhere near the current price.
What sets last week’s short squeeze apart is that this time there appears to be as many losers as there are winners. Puts and calls are derivative instruments. For every buyer there is a seller. For every winner there is a loser. The danger isn’t some little guy going broke or even a hedge fund or two. The risk is the system breaking down. We saw this in 2008 as brokers failed serially. In 1987, the failure of portfolio insurance sent stocks crashing. In the late 1980s it was leveraged buyouts and attacks by large institutional investors against weak Asian currencies that riled markets. In the mid-2000s, it was collateralized mortgage obligations that collapsed along with a housing boom fed by easy money.
But the Fed doesn’t see it that way. It keeps pumping in another $5 billion per day.
The GameStop story will end. Maybe it will even bring down a smallish brokerage or a few hedge funds. But as long as the Fed keeps pumping, other bubbles will emerge.
Easy money has its place, when the economy needs a good jolt in the arm. I recognize that this is still a fragile economy. I see the lines of people waiting for food. I see 800,000 unemployment claims filed every week. But the problem isn’t lack of money. Our money supply is growing at a 25% annual rate. The problem is that the money keeps going to the wrong places. Asset prices are exploding while too many people are hungry and out of work. That isn’t the Fed’s problem, it’s Congress’s. The Fed can’t solve it. In fact, by keeping rates so low that bank accounts can no longer provide any income, it can be argued that the Fed is part of the problem.
When more money chases limited supply, prices erupt. As prices rise, momentum investors chase. They become emboldened. Euphoric. Non-sensical.
When the bubble bursts those caught in the eye of the storm will get hurt the worst. When GameStop goes back toward $20, someone is going to lose a lot of money. If he owns GameStop with leverage, then he will have to sell something else to cover his losses. That is why when these bubbles burst, the damage spreads. The farther away one is from the epicenter, the pain will be less. But no one is immune.
It isn’t just GameStop investors that are exposed. It is owners of those SPACs and IPOs
whose story lines will be much larger than future reality.
I have no idea where GameStop will trade today or tomorrow. No one does. Its value no longer relates to anything fundamental. Its price is completely a function of whether there are more buyers or sellers at any given moment. No one is buying or selling on anything resembling fundamentals anymore. It is simply rank speculation on both sides. In the short run, emotion trumps the facts. In the long run, the facts always win.
Thus, this will end, probably soon. Undoubtedly with some collateral damage. But until the Fed stops feeding ever more money into markets that already have a supply/demand imbalance, and as long as it keeps bond prices artificially high, distortions will continue. Jerome Powell is right. He can’t, nor should he stop, someone from speculating. But just as homeowners who never had the balance sheet to own a home got foreclosed in the financial crisis, investors today are making similar dopey decisions with money so loose and cheap. I realize that when the Fed says it might slow the pace of bond buying, markets will react negatively. But that doesn’t mean markets should tell the Fed what’s right or wrong. It’s time for the Fed to ask what are the risks and rewards associated with its plan to keep buying $5 billion of securities each and every day.
Today, Lisa Marie Presley, Elvis’s daughter, is 53.
James M. Meyer, CFA 610-260-2220