Today’s Stock Market Is The Exception, Not The Rule

Today’s Stock Market Is The Exception, Not The Rule
Andrew Rummer

about 3 years ago3 mins

Mentioned in story

What’s going on?

As the dust settles on the GameStop saga – a textbook bubble that saw the struggling game retailer’s share price soar from $17 to nearly $500 in less than a month before crashing back down to earth – let’s take a look at how we got here and where things might be headed next. 

What does this mean?

First off, it’s clear that the dismissal of small retail traders as “dumb money” no longer holds water – if it ever did. While Bloomberg or Refinitiv terminals may still give pros at investment banks and hedge funds an edge, the proliferation of low-cost online investing tools like Koyfin and Atom Finance has narrowed the information gap substantially. 

A consequence of this is that the analysis presented last August by Keith Gill (a.k.a. RoaringKitty, a.k.a. DeepF*ckingValue) pitching why GameStop could rise to $50 a share wasn’t a million miles away from the arguments a Wall Street bank might present to clients – even if the medium was. (Although I doubt Keith ever in his wildest dreams thought the stock would approach ten times that level.)

Yet while those early traders jumping into GameStop at $10 or even $20 may have been working off a sound fundamental thesis, this is harder to justify for those jumping on the bandwagon at $200. Unfortunately, if GameStop was your first experience of stock markets then it may well have been a baptism of fire. Those unlucky enough to have bought the stock at its January 28th peak of $483 would currently be sitting on a 90% loss. 

GameStop share price
GameStop share price (Source: Bloomberg)

Why should I care?

The GameStop affair dredges up some of the stranger short-term trends lurking beneath the surface of markets today. If you’ve just started investing, you may not realise what a strange period we’re living through – and that lack of historical context might trip you up. 

Just look at how well small investors’ most popular stocks have performed since the US S&P 500 index bottomed on March 23rd last year. The chart below shows how investment bank Goldman Sachs’ “retail favorites” index – a measure of the 50 or so stocks most frequently owned by individuals (in yellow) – has pulled away from the wider market (in blue). 

Chart of retail investors' favourite stocks
Source: Charles Schwab, Bloomberg, Goldman Sachs

Small investors who only got into investing after the pandemic took hold are likely to be sitting on some healthy returns – and perhaps starting to believe the “stonks” meme that markets only ever go up. But look back a few years and you’ll see that retail favorites’ recent outperformance is highly unusual.

Chart of retail investors' favourite stocks before March 2020
Goldman’s index is again in yellow, with the S&P 500 in blue (Source: Bloomberg)

The most-shorted stocks exhibit a similar trend too. New investors may be tempted to conclude that high “short interest” – where lots of people are betting that a stock’s price will decline – is a surefire sign of an imminent rally. But the bigger picture instead shows that, over time, the most-shorted stocks tend to perform worst and the least-shorted stocks best.

Chart showing performance of most-shorted stocks
Analysis is of the US Russell 3000 index (Source: Charles Schwab, Strategas Securities)

As a final thought, I’d challenge those who claim that this unusual market behavior is attributable to all the financial support flowing from the US Federal Reserve and other central banks. Interest rates have certainly fallen – but the idea that GameStop wouldn’t have happened if you could earn 3% rather than 0.1% on your savings account just doesn’t wash with me. 

It’s important to remember that even every retail investor combined is little match most of the time for the sheer weight of capital deployable by major investment funds. The events of recent weeks and months should be put into their proper context: as long as there have been markets there have been speculative frenzies, and they always eventually end. Moreover, they end with the people who bought in last losing a lot of money…



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