The Better Letter: Markets, Bias, and Incompetence
GameStop is an important story, but not an important *market* story
“Every age has its peculiar folly; some scheme, project, or fantasy into which it plunges, spurred on by the love of gain, the necessity of excitement, or the mere force of imitation.”
That quote is from Charles Mackay’s 1841 classic, Extraordinary Popular Delusions and the Madness of Crowds. It was right then and it’s right now. In fact, it’s right, right now.
Over the past couple of weeks (as I discussed in a special edition of TBL last week), the allegedly rational market has been anything but. Instigated by an internet hoard (led by the WallStreetBets thread on Reddit) that decided it might be funny, righteous, and perhaps even profitable to take on a few major hedge funds, juiced up the stock of GameStock and a few other “meme stocks” to squeeze the monied elite. Fandom trumped fundamentals to stick it to the man. Or something.
The democratization of finance, fueled by social media, allowed small, retail investors to act big, together, and with a common purpose so as to monetize a hidden asset – the ability to spot internet trends and memes before others … by creating them. It seems like the latest iteration of the perfect metaphor for our times.
Think of it as trolling with real money – what became tulipian money, at least for a little while – to stick it to some rich guys who looked an awful lot like the Duke brothers. As one WSB investor noted, “It’s time for the common person to be on the same level as these hedge funds.”
The New York Times closed its write-up on the $GME’s wild ride with the wife of an evangelical pastor who is also a Redditor investor exclaiming, “Eat the rich.” I’m sure she said it in love.
The basic elements that attracted people to the GameStop buying frenzy and the feedback loops that became a gamma squeeze had nothing to do with GameStop’s business per se. By any objective measure, the stock isn’t worth anything like $50 per share, much less its recent high of $483. What attracted people to the trade were the volatility, the prospect of getting rich quickly, the meme-ness of it, and the various morality play elements imposed on the stock price by the parties, the political world, and the media.
Of course, for the reasons discussed last week, the frenzy couldn’t last. GameStop has recently gotten crushed; its value has collapsed more than 80 percent this week as retail traders bailed (after the institutions). The video-game retailer tumbled 42 percent just yesterday to $53.50, erasing nearly $30 billion in market value in one day. The losses continued in after-hours trading. I was right last week when I said, “A lot of money is going to be set on fire.”
Ultimately, an asset – real or imagined – has value if people will buy it. It needn’t produce products people want or meaningful cash flows. People desire gold as and for jewelry (we like shiny objects, literally and metaphorically), but there is a lot more involved in its price than that.
Fundamentally (and not surprisingly), Matt Levine got it exactly right.
“I don’t think, however many days we are into this nonsense, that GameStop is a particularly important story (though of course it’s a fun one!), or that it points to any deep problems in the financial markets. There have been bubbles, and corners, and short squeezes, and pump-and-dumps before. It happens; stuff goes up and then it goes down; prices are irrational for a while; financial capitalism survives.”
It isn’t an important market story. It is, however, a significant (if unsurprising) political and media story. And that’s the subject of this week’s TBL.
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Markets, Bias, and Incompetence
I remember a conversation with one of my basketball player friends at Duke like it was yesterday. We were talking about how he had been quoted hundreds of times in the media (newspapers, mostly). It was four decades ago, so the media landscape was entirely different, of course. But I have never forgotten the crux of the conversation.
“They were all friendly and the quotes all made me look good. They wrote things I could have said, should have said, might have said, or sort of said, but never what I actually said. Not one time. The reporter always had a story to tell and used me to tell it.”
So it is with the GameStop saga. It’s true about most journalists and it’s true about official Washington, political actors, and would-be actors generally, too.
However, after the first wave of stories and attempted explanations, seemingly everyone (except those who understand markets and know what they’re talking about) came to agree on the primary $GME narrative: Robinhood stepped in to put the kibosh on small, retail investors to protect the hedge funds who had shorted $GME, expecting its price to go down, were made wrong by the Redditors, and were now bleeding cash. In the process, the story goes, the retail investors were frozen out of a once-in-a-lifetime (#YOLO) profit opportunity.
For once, the little guy was sticking it to the man but the man turned the tables and did the crushing.*
Let Elizabeth Warren tell the story.
As a major supporter of Dodd-Frank, then and now, she ought to know better (and almost surely does).
Sen. Josh Hawley may have been too busy trying to overthrow an election to pay sufficient attention to the markets, but his response to the GameStop debacle, like Sen. Warren’s, is shockingly and knowingly wrong: “anyone with a clue how trading works knows that framing is nonsense.”
Tucker Carlson and would-be political populist Dave Portnoy of Barstool Sports make the same claims.
It’s impossible to tell if the narrative fallacy is at work, hiding the truth from otherwise good and smart people or, as is more likely, they know they’re wrong and spew anyway because there are views and clicks and votes in it.
What follows is a brief reminder of how and why the persistent and favored David against Goliath narrative is wrong — clearly and badly wrong. We’re dealing with what Kris Abdelmessih calls the conspiracy theorists and the ambulance chasers: “the arc of moral outrage bends towards grift.”
As a preliminary matter, the entire premise of the story is bogus. If various hedge fund billionaires, per the favored narrative, were truly rigging and manipulating the markets, you’d think they wouldn’t suck at it.
As Morgan Housel said, there just a few hedge funds that one can reasonably expect to beat the market after fees with any degree of consistency, and none of them is taking money from the likes of us. They are the unicorns that keep the thousands of other funds in business. These lousy hedge funds – which is to say the vast majority of them – earn roughly one-third the performance of the S&P 500, charge 30 times the fees of typical funds, “pay half the income tax rates of school teachers, have triple the ego of rock stars, and fewer disclosure requirements than the NSA.”
There are lots of believers in investment secret sauce or, at least, folks who want to believe. Exclusivity sells, too. Any idiot with more certainty than sense and good sales technique can open a hedge fund and has a decent chance of making a go of it.
The pitch has altered over time. When I was in a pre-launch meeting for the infamous Long-Term Capital Management, the pitch was very straightforward: We’ll make you a boatload of money without much risk (we’re hedged). That worked brilliantly for a few years until it didn’t.
So, the pitch evolved to beating the market, to market-like returns with lower risk, to better risk-adjusted returns, to only decent but smoother returns, to modest but non-correlated returns.
Still, hedge funds remain a spectacular fee-acquisition vehicle. Performance comes and goes. Fees never falter, as Warren Buffett said.
The chart below shows the return in dollars of the S&P 500 and the average hedge fund return for the ten years from 2011 through 2020. In each of those ten years, the return on the S&P was greater than that of the average hedge fund, in seven of those years the return of the S&P was at least as high, and in four of those years it was at least three times as high. Over the decade, the average annual return of the S&P 500 was 14.4 percent, almost three times higher than the 5.0 percent average return for hedge funds. Moreover, a standard 60:40 portfolio (S&P 500:10T; data here) more than doubled the performance of hedge funds.
If hedge funds have really rigged and are constantly manipulating the markets, they would make more – a lot more – than you can make in your S&P 500 index fund. Instead, they make far, far less.
While $GME lost 83.5 percent of its value this week, the S&P closed at yet another all-time high yesterday. Since October 30, the S&P 500 has rallied 18.4 percent.
Other than a very few outliers, hedge funds haven’t. So much for rigging the markets.
Secondly, the facts as frequently recited are simply wrong. There are huge institutional players on both sides of the $GME trade. The company’s largest shareholders, according to its most recent securities filings, are Fidelity and BlackRock. As part of various indexes, such as the Russell 2,000, the Russell 3,000, and the S&P SmallCap 600, GME is owned by any and all institutions and retail investors who own various index-tracking funds.
Famed investor Michael Burry (played by Christian Bale in the film, The Big Short) bought $GME before the Redditors did. Big hedge funds made a ton of money trading $GME. And the Redditors are hardly the little guys they are portrayed to be. It’s hardly David versus Goliath.
Most importantly, the populist narrative is a conspiracy theory without any factual basis. If Robinhood and various hedge funds were truly acting crookedly, there would be evidence rather than mere suspicion. Didn’t we just endure a major constitutional crisis because somebody claimed the system was rigged without evidence? You’d think we might have learned a little something.
The conspiracy theories about Robinhood suspending trading in $GME in order to service Citadel, as recounted by Kris Abdelmessih, can be cut to shreds with both Occam’s and Hanlon’s razors. If you want the details, read Kris’s excellent post here, one by Packy McCormick here, and this one by Byrne Hobart. If you want to understand the particulars of the plumbing, read this Twitter thread.
Free options trading at Robinhood with easy margin probably made some sort of catastrophe inevitable. Robinhood got exactly what it incentivized so nobody should be surprised.
There is, of course, political hay to be made, facts being largely irrelevant in that regard. The SEC said it will “act to protect retail investors when the facts demonstrate abusive or manipulative trading activity.” Promising a hearing, House Financial Services chair Rep. Maxine Waters said in a statement: “We must deal with the hedge funds whose unethical conduct directly led to the recent market volatility and we must examine the market in general and how it has been manipulated by hedge funds and their financial partners to benefit themselves while others pay the price.” State attorneys general will investigate.
But there is no evidence of hedge fund manipulation (at least thus far). Robinhood didn’t break the law (so far as we know). It didn’t pick big guys over little guys. Robinhood was utterly self-interested. It will likely and deservedly lose business. It fumbled its messaging around these events badly and wasn’t nearly transparent enough. Evil may have been involved, but not illegality (and stupidity surely was). Regulation may be coming, however, because everyone in Washington, D.C. (e.g., AOC and Ted Cruz) seems to agree that Robinhood is bad.
Politicians, political actors, and journalists want to portray themselves as purveyors of truth and, especially, as bravely speaking truth to power – even when they have the power.
In the same way that hedge funds are in the fee acquisition business rather than the investment performance business, politicians, political actors, and journalists are in the attention business with truth – at best – a happy accident or unintended side effect. As we have seen above, all too often, for them, truth is something to be avoided, dodged, or denied.
There is very good reason for that.
To be clear, some journalists (e.g., Matt Levine; Jason Zweig) and some outlets (most prominently, The Wall Street Journal) got the $GME story substantially and often incisively right. They were the exceptions rather than the rule.
Matt Levine surveyed the damage yesterday.
People on Reddit who got into it early have made small or occasionally biggish fortunes.
Hedge funds that were long early and hedge funds that were short late, like Mudrick Capital Management, have made large fortunes.
Hedge funds that were short early, like Melvin Capital, have lost large fortunes.
Intermediaries—high-frequency traders, options market makers, brokerages—have been a bit cagey about how they’re doing, and have had a stressful couple of weeks, but there is a widespread sense that they mostly made a lot of money.
The financial system will survive just fine, thank you.
People on Reddit who got into it late have lost — well, most of the money they put in, anyway (more here). One hopes that was mostly fun gambling money, because by the time they got in this was incredibly transparently stupid and they had to know they’d lose everything. There are already stories about people losing more money than they could afford to risk, and there will be more.
My summary last week was pretty good: “A lot of money is going to be set on fire.” It isn’t hard to smell the smoke.
The second-order implications of this get very interesting. If it is obvious that the dominant media/political narrative is dead wrong when its subject is within your strong domain knowledge, what does that say about such narratives then they are outside your domain knowledge?
* If you call yourself a “hedge” fund and you don’t hedge your short position in an already beaten-up stock even though everybody and his brother are trying to crowd-in on the trade, I don’t want to stick it to you because you’re rich. I want to stick it to you because you’re stupid and deserve it.
My darling bride and I were vaccine chasers at Petco Park in downtown San Diego this week. Neither of us was yet eligible to receive the vaccine by appointment. But, if we were lucky, we could get leftover doses.
On Tuesday evening, there were no leftovers. However, on Wednesday, there were. And we were very lucky (blessed) indeed.
About half-an-hour after the last vaccination appointment of the day, an official came out to where a few hundred of us were waiting in line with a bullhorn and a security guard. The oldest people there would get vaccinated for as long as there were available doses. The official started at age 80 and counted down. When he got to 67, he got his first patient and the crowd cheered. DB and I got called soon thereafter and each of us, along with 65 other vaccine chasers, received a first dose of the Moderna vaccine and an appointment for a second four weeks hence. So far, we have no significant side effects other than sore left arms.
It was seven hours well spent.
We are most grateful for the scientists and doctors who developed the vaccine, the staff and volunteers who administered it, and the government programs that made it possible. It is a medical marvel.
Totally Worth It
Don McLean’s classic song, American Pie, is now 50 years old. I loved it 50 years ago and I love it today. I still love to roll the windows down in the car, put on the song, jack up the volume, and sing … loudly. In honor of the anniversary, McLean recorded a new acapella version – released this week – with Home Free. It’s fantastic. And I’m still trying to figure out what was revealed the day the music died. Give it a listen.
My 10th annual Investment Outlook (for 2021) is available here.
This week’s benediction combines a wonderful Psalm of praise and gospel music that cooks with gratitude. It features the amazing Brooklyn Tabernacle Choir.
Every day calls for gratitude. Today especially.
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Thanks for reading.
Issue 51 (February 5, 2021)