THE start of 2021 ushered in a number of changes for the US with the swearing in of a new US President and a number of policy changes by this new administration. The US stock market also experienced increased volatility as the VIX index, which measures the market’s projections of volatility in the coming month, increased by 62 per cent on the January 27, 2021, from 23.02 the day before and remained above 30 until February 2, 2021.
The trend in the VIX curve almost mirrors the pattern exhibited in the lead-up to the presidential election in early November 2020. However, this time, the impetus was due to unusual and highly targeted trading from a cohort of retail investors (Reddit-driven traders) and hedge funds.
The volatility overshadowed optimism earlier in the month that stemmed from an anticipated fiscal stimulus boost following President Biden’s inauguration. Much of the volatility in the US stock market surrounded a few stocks – in particular GameStop whose stock price skyrocketed by 1,745 per cent in just one month.
What fuelled GameStop price increase?
GameStop Corporation operates specialty electronic game and PC entertainment software stores and sells new and used video game hardware and software, as well as accessories.
The pandemic created a shift in consumer buying behaviour away from brick and mortar establishments, such as GameStop and towards buying games online, which negatively impacted the company’s sales. Despite no significant changes to the company’s business model or no positive earnings release, the company’s share price increased significantly, reaching US$347.51 on the January 27, 2021 from US$18.84 at the end of December 2020.
Companies whose share price is low or falling are prime targets for short-selling strategies, which comprise borrowing shares from someone, usually an institutional investor such as a pension fund, and selling the shares on the market with the intention of purchasing the share at a later date at a lower price and returning the shares to the owner.
Given GameStop’s challenges and the impact on their share price, institutional investors, including hedge funds, saw an opportunity to make profit from betting against GameStop’s share price, or short selling.
However, a peculiar trend emerged early in the year as users on the WallStreetBets forum of the social news platform Reddit decided to buy into GameStop shares initially as some investors deemed the share price to be undervalued while others wanted to send a message to the short sellers.
Acting together, the investors increased the demand for GameStop stock and pushed up the share price significantly, putting pressure on the short sellers (a process known as a short squeeze) which resulted in massive losses for short-sellers. The losses suffered by short sellers are estimated at roughly US$5 billion on GameStop for 2021 thus far.
Spill over into other stocks
This phenomenon extended into other stocks as retail traders using twitter and other social platforms helped to fuel rallies in BlackBerry, AMC and American Airlines, and of late in biotech companies such as Atossa Therapeutics Inc and Anavex Life. Of recent, the retail investor frenzy targeted Silver, sending the precious metal to a five-month high in early February.
This new trend has caught the attention of the regulators as the Securities and Exchange Commission (SEC) issued a statement on January 29, 2021, expressing its commitment to protect retail investors from abusive or manipulative trading activity. The SEC also warned investors to avoid such activity. The Treasury Department convened a meeting of top financial regulators to discuss the volatility in the market.
Navigating such Volatile Times
While the GameStop and AMC bubble has effectively burst, with the share prices falling by 86 per cent and 59 per cent to just over US$50 and US$5.50 per share respectively on the February 9, the Reddit raids on individual stocks or industries have not stopped. If this short squeeze continues, then the market may be purged of all short sellers which could lead to a more volatile market.
Investing is a discipline that requires patience and consistency by investors and short-term ‘get-rich’ trends should be avoided. Investors who jump on the bandwagon and buy such sought-after stocks, run the risk that the stock is purchased at the peak and when the bubble bursts, the investor may be forced to sell low.
Timing the market is impossible and investors should have an investment plan and stick to it.