GameStop’s saga may be over; its effect on Wall Street isn’t

The frenzy around GameStop’s stock may have quieted down, but the outsized influence small investors had in the saga is likely to stick around.

No one expects another supernova like GameStop to happen again, where a band of smaller-pocketed investors helped boost a struggling company’s stock 1,000% in two weeks. But the tools they employed can be used again and again, if those smaller investors stay connected on social media forums and if regulators don’t change the rules to hinder them.

These smaller players, called “retail investors” in the industry to differentiate them from hedge funds and other big firms, are using many of the same tactics as the professionals, after all. And if retail investors continue to hold greater sway, the result will likely be sharper swings for some stocks than they would have had otherwise, if not to GameStop’s spectacular degree.

GameStop’s wild ride is causing some professional investors to gird for more volatility in the market and politicians in Washington to ask who is getting hurt. A House committee is calling several of the GameStop saga’s players to a hearing on Thursday, titled “Game Stopped? Who wins and losses when short sellers, social media and retail investors collide.”

“I don’t think we’re going to see major reforms that prevent it,” said Tony Casey, a professor of law at the University of Chicago, of the rise of social-media-driven trading. “All the parts in this will still be here in a few years, and we will likely see versions of it.”

Exhibit A may have come even sooner than many expected. Just last week, stocks of several pot producers burst higher, with medical-marijuana grower Tilray more than doubling in three days, only to more than halve in the next two. Some of the surge was due to actual news, including a Tilray deal to distribute medical cannabis into the United Kingdom. But smaller investors also piled into the stocks.

“Time to get on the cannabis bandwagon if you ain’t,” one user posted on the WallStreetBets forum of Reddit, a hub for smaller investors and perhaps the launch pad for the GameStop saga.

The cannabis trading does, however, lack one key element of the GameStop drama: It’s decidedly not about sending a message to hedge funds. It’s more about the thrill of making bold trades that may explode in a good or bad way and the camaraderie of sharing the gains and losses with others on the internet.

In the long term, a Wall Street adage says that “the fundamentals” always win out. That means a stock’s price eventually settles where it should, based in part on how much profit a company is producing. The recent plummet back to earth for GameStop’s stock may be proof of that.

What GameStop did, though, was show how a group of smaller investors banding together can dramatically push up a stock in the short term. Many market watchers believe hedge funds and other professionals also played a role in GameStop’s surge, but they were likely only accelerating the spurt sparked by retail investors.

The market had seen similar events before. Last summer, Wall Street was shocked as shares of Hertz rose even though they were on the road to likely becoming canceled and worthless, because the company was in bankruptcy protection.

The movements can be even more spectacular if a stock has heavy bets built up against it, bets that would profit if its share price were to fall. That can trigger what’s called a “short squeeze,” where a rise in a stock’s price pushes skeptical traders to scramble out of their bets. To do so, they have to buy shares of the stock, which pushes the price even higher and creates a feedback loop. GameStop was an extreme example because some of its shares had been sold short multiple times.

Now, smaller investors are the ones who could be doing the squeezing. Collectively, they account for 20% of all trading volume, said Pauline Bell, analyst at CFRA Research. That’s up from 10% to 15% during 2019 and most of 2020.

Giving those smaller investors even more heft is the communication they can do over social media. That’s one part of what makes the recent movement an evolution from the day-trading craze of the late 1990s.

It was cool then for retail investors to ride tech stocks like JDS Uniphase higher, but while they had access to internet chatrooms they didn’t have a Reddit or other social media to quickly amplify their voices and convince others to get in as well. They also didn’t have the ability to trade stocks on their phones, while sitting on a couch with little else to do amid a pandemic, all while paying zero commissions.

“We believe a structural change may be afoot and that retail investors are likely to remain bigger players in the U.S. equity market going forward,” Lori Calvasina, head of U.S. equity strategy at RBC Capital Markets, wrote in a recent report.

Consider Bartosz Skoku?, a 27-year-old computer programmer in Wroclaw, Poland. His investments were fairly conservative until he bought GameStop shares a month ago, after a friend told him about it and Reddit’s WallStreetBets.

He made a healthy profit on GameStop, and he expects to stay connected with WallStreetBets, sifting through the many stock ideas that users pitch on the forum to find opportunities he likes. Some of the ideas on what’s known as r/WSB are brilliant, he said, and others are “totally stupid.”

Therein is the beauty of it, he said: “those people share their ideas and effort for FREE because they can talk with others, discuss about it, learn in a group. If there is something like r/wsb power – it is that!” The group has more than 9 million members, many sharing due diligence on their ideas.

What could curtail the influence of of smaller traders? A stiffer regulatory hand from Washington, for one. Thursday’s hearing before the House Financial Services Committee will have testimony from the CEOs of hedge funds, the company behind the popular Robinhood trading app and Reddit. It will also include a prominent user on Reddit’s WallStreetBets who was an early believer in GameStop’s stock.

Washington could choose the paternalistic route and restrict trading for smaller investors, so they can’t push a stock’s price up so easily and get burned later if it drops, said the University of Chicago’s Casey. But that would anger retail investors who want to trade as freely as hedge funds do.

Politicians could instead target short sellers, “but Wall Street is not a powerless lobby either,” Casey said. The industry says short selling helps make markets more efficient.

Another deterrent may be the pain that some retail investors are nursing after buying GameStop for $450 and seeing it now closer to $50. But even there, there’s skepticism.

“I’m hopeful that some of those speculators learned their lesson," said Rich Weiss, chief investment officer of multi-asset strategies at American Century Investments. "But it seems like this is a lesson that people need to be reminded of, over and over again.”