Skip to Content
Rekenthaler Report

There Are No Stock Market Heroes

Even when the transactions appear to be personal, they're strictly business.

Mentioned: ,

High Times
Although the magnitude startled me--the stock gained 2,500% in two weeks--GameStop's (GME) surge was not otherwise remarkable. That individual investors have been in a mood since the COVID-19 shutdown has been evidenced by, among other items, the gains of Tesla's stock (TSLA) and Bitcoin. Enthusiasm reigns.

Broadly speaking, today's market climate resembles that of the late 1990s. Then, too, upcoming individual investors were aggressive, trading Internet stocks from accounts they had established within discount-brokerage firms. They also brandished their youth as a virtue, believing that they understood technology better than did their stodgy elders. (Likely true.)

Their behavior was isolated because there was no practical method for uniting them. Thus, while the underlying conditions for the two eras are similar--a rising investor class that sought to push aside its predecessors--the outcome has been different. Thanks to social media, today's Young Investment Turks are organized. They use the power of their numbers to force market prices to obey their will.

All of which is fine. No laws prevent people from collectivizing investment ideas. Quite the contrary; the Investment Company Act of 1940 was enacted so that shareholders could do just that. (Socialism!) More to the point, investment clubs have historically served the same function, but in nonregulated fashion. The Reddit forum WallStreetBets, or WSB, which kicked off the GameStop frenzy, is in effect a virtual investment club.

The Morality Play
It is, however, an investment club with attitude. WSB readers bought GameStop for two reasons. One was profit. Because the company's stock had been heavily shorted, a steep rise in its price, which WSB investors could generate by buying GameStop en masse, would lead to an even-greater gain after those short-sellers became squeezed. The second motive was morality. Not only could GameStop buyers punish short-sellers, but the rally would also damage hedge funds, which held most of those short positions. Win-win.

This narrative surprises me, because until recently, short-sellers were popular heroes. In December 2015, the movie The Big Short debuted, to both critical and popular acclaim. Among the film's leads was Dr. Michael Burry, portrayed by Christian Bale, who shorted collateralized mortgages in his hedge fund. Another was Steve Carrell's character Mark Baum, based on real-life investor Steve Eisman, who (yes) managed a hedge fund and (yes) shorted investments.

From idols to bums in half a decade! The transformation is remarkable. It also strikes me as being entirely wrong.

A Hero Is Nothing but a Sandwich
To start, Burry and Eisman were not heroes. They were professionals who saw the chance to make an investment buck. That was their job, and not a particularly dangerous or noble occupation at that. They neither risked nor saved lives. Admittedly, their trades were financially hazardous--but so, too, is the launch of any local restaurant, which places the founder's capital at risk. If there are films that celebrate the bravery of those who own diners, I have yet to watch them.

What's more, The Big Short's transactions only profited if homeowners failed. Those investments would languish unless mortgage defaults increased. Quite literally, for Burry and Eisman to be vindicated--that is, for audiences to cheer the success of the film's protagonists--residential homeowners needed to suffer.

Phrasing the matter that way--which is how GameStop's current shareholders now view the issue--makes short-sellers sound depraved indeed. But plenty of long positions also profit from unhappiness. Pharmaceutical companies require medical conditions that need curing, as do hospitals and medical suppliers. For their part, insurers would not exist were there not natural disasters, thefts, and accidents to protect against. Is it unethical to own stock in such companies?

In summary, neither The Big Short's portrayal of short-sellers as champions nor WSB's belief that they harm innocent parties can be justified. Whether their positions are short or long, investors are investors. And if short-sellers sometimes exaggerate their target's shortcomings, so as well do those with long positions. Investment hype flies in both directions. (Elon Musk attacks short-sellers but not those who predict grand achievements for his company.)

Nor should hedge funds be regarded as villains. In truth, that charge is difficult to understand. Ultimately, it seems, the belief arises more from symbolism than from actual events. The problem is not crimes that hedge funds have committed--Overcharged their customers? Underperformed the stock market?--but instead what they represent: Wall Street at its most privileged and coddled.

Not Guilty
If there is a bad actor in these proceedings, perhaps it is the WSB investors themselves for disrupting the stock market. Some observers have advanced that very argument. An editorial in The Washington Post reads, "The Good Guys in the GameStop Story. It's the Hedge Funds and Short Sellers." For its part, Bloomberg opines, "GameStop Mania is Delivering a Dangerous Rush to the Reddit Mob."

I disagree. Ultimately, neither the motives of WSB's readers nor their methods deserve criticism. If GameStop's buyers invested for personal reasons as well as pecuniary, that is their right. The stock market does not test investor intentions. And if those trades were legal, as with the GameStop purchase, it is nobody's fault if the market wobbles. If the regulators perceived a problem, then they can devise a solution to prevent its reoccurrence.

In short (so to speak), the stock market's workings are purely business. Whether participants are motivated solely by the wish to make money or have other desires is immaterial. Those who bought GameStop were not nobler than those who had sold it short. Neither, however, should their behavior be blamed.

 

John Rekenthaler (john.rekenthaler@morningstar.com) has been researching the fund industry since 1988. He is now a columnist for Morningstar.com and a member of Morningstar's investment research department. John is quick to point out that while Morningstar typically agrees with the views of the Rekenthaler Report, his views are his own.

John Rekenthaler does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.