This take out from CNN is askew in my estimation, and I’ll tell you why. First, CNN:
No matter what happens next to shares of GameStop and AMC or the price of silver, average Joes and Janes are now an undeniable force to be reckoned with on Wall Street.
Nope. The best case you can make for this is that small investors can make a wave in a very specific set of circumstances. This short squeeze only worked because people on Reddit found out about one hedge fund who was significantly shorting. Absent that information, it doesn’t work.
The short squeeze last week that propelled GameStop (GME) and other momentum investments popular with the Reddit crowd now appears to be on hold. GameStop plunged more than 50% Tuesday while AMC (AMC), silver prices and silver mining companies also fell sharply.
That’s partly due to trading restrictions from Robinhood and other brokers on how many shares of volatile stocks like GameStop, AMC (AMC), Express (EXPR) and Nokia (NOK) that retail investors can purchase in a single stock at a time.
The big hedge funds have liquidated their positions in GameStop and AMC. This 50% plunge is now little investors finding that they’re the last ones standing as the music stops in a game of investing musical chairs.
But heavily shorted stocks could wind up rallying again.
Or they could continue to plummet back to their original intrinsic value of roughly $18 a share. The point is nobody knows and all this is stock market gambling. Once you divorce a stock from rational value, anything is possible. Typically these occurrences are short-lived. In other words, I can’t think of a long-term example.
Derhalli pointed out that as younger investors increasingly start buying and selling stocks, the market will need to adapt. He said the rise of other popular stocks, such as Tesla (TSLA) and Beyond Meat (BYND) are due partly to Millennials and Gen Zers investing in brands that they know and like.
“Younger retail investors are in touch with changes taking place. They understand consumer trends because they are the ones making and creating them,” Derhalli said. “There are some Millennials making a lot of money and there are hedge funds pissed off that retail investors have joined the game and are beating them at it.”
Yet a number of Wall Street veterans are concerned that this won’t end well for smaller investors.
The lottery-like atmosphere surrounding GameStop, AMC, and Tesla means that Wall Street veterans are correct: This won’t end well for small investors. To take one example, Tesla is currently trading at a price-to-earnings (P/E) ratio of 1312. That stratospheric number is no typo. Tesla stock is completely unmoored from intrinsic value. And I say this someone who like Tesla, and owns a Model 3. For comparison, Apple has a P/E ratio of 35 and that’s high for the company by historic standards.
The PEG ratio (Price/Earnings to Growth) helps calculate whether a stock is a good value. Famed investor Peter Lynch used a PEG of 1.0 to denote equilibrium, meaning a reasonable purchase. A PEG over 1.0 meant a stock was overvalued compared to growth; a stock under 1.0 was considered undervalued and a good buy. Tesla has a PEG ratio of over 8. GameStop doesn’t have a PEG ratio because, you know, it has no growth.
But there are some major differences between now and two decades ago — not to mention the Great Financial Crisis of 2008-2009, a time when social media and free online trading weren’t as ubiquitous as they are now.
Average investors can now trade more efficiently and in a cost-effective manner thanks to no-fee brokerage firms such as Robinhood — a move that essentially forced all the other major brokerages to drop commissions.
The rise of fractional trading (i.e. owning a set dollar amount of a high-priced stock like Amazon or Alphabet) and the popularity of index ETFs also makes it easier for investors to buy small pieces of many stocks.
And Reddit’s megaphone is significantly louder and more influential than the old chat boards of the late 1990s.
All this says to me is that we’ve collectively made it much more efficient for a lot of people to lose all their money faster than ever before.
“I have respect for those who saw what was going on, how it worked and exploited it,” he said. “But what value has been created?”
This is the larger point: No value has been created whatsoever. We’re just watching people play a game that does nothing to improve the world. There is a lot of that on Wall Street, and I’d be an advocate for changing it.
Stocks like GameStop and AMC aren’t increasing in value because they’re producing high revenue and profit, paying big dividends or adding significant juice to the economy by creating thousands of jobs.
Indeed, a case can be made that small investors have only delayed the inevitable closing of soon-to-be bankrupt companies, injected adding inefficiency into the markets. That’s no tragedy, but it’s not terribly helpful either.
But that misses the point. There is no rule that says investors should only buy large blue chip companies. Some investors are growing tired of buying safer, passively run index funds and want to gamble.
That is correct. People want to gamble. This is not good for them, for companies, for other investors (necessarily), or for the markets, but that’s what they want to do. I’m not an advocate for stopping them, but I’m not in favor of making it easy either. We should raise the short-term capital gains tax and lower the long-term capital gains tax. If that’s not enough of a disincentive so be it. At least we can fund useful, real world things with the proceeds.