GameStop shares have come back to earth, reaching an intraday high of $483 in late January but closing at $51.10 per share today, and other stocks that were caught up in this whirlwind have retreated as well.
Yet we get the sense there is still some unease among individual investors about what happened, and about the risks that this may pose for the overall market. Some are wondering, does this episode indicate there is something bigger going on? After all, another group of small so-called “meme stocks” have pushed higher in recent trading sessions.
To this we say yes, there is definitely something bigger afoot—much, much bigger.
However, the root cause is not necessarily top of mind and is not even market-related. Moreover, we don’t think the phenomenon is a serious threat to traditional investment portfolios.
A 21st century twist on the short squeeze
First, consider how the GameStop episode played out: It was a classic, painful short squeeze, but it unfolded in a novel and dramatic fashion.
Short squeezes have happened for many decades, and some of the most high-profile episodes even go way back to the Roaring 1920s when the total value of the stock market was much smaller. Many readers’ eyes would glaze over if we go into the details of how shorting works and how short squeezes play out, so we will forgo the particulars. (A simplistic definition from Investopedia is in the chart.)
What goes up during a short squeeze can come crashing down
GameStop (GME) daily high and closing price per share
The chart depicts the price surge in GameStop (GME) shares during the recent short squeeze and its subsequent descent as the process unfolded.
Daily high price
Daily closing price
Short squeeze: "When a stock or other asset jumps sharply higher, forcing traders who had bet that its price would fall to buy it in order to forestall even greater losses. Their scramble to buy only adds to the upward pressure on the stock's price ... Short sellers are being 'squeezed' out of their positions, usually at a loss." — Source: Investopedia
Source - RBC Wealth Management, Bloomberg, Investopedia; data through 2/10/21
The difference this go-around is the GameStop short squeeze unfolded in a unique way.
The proliferation and wide use of internet chat boards—in this case on the Reddit platform, primarily—opened the door for individual investors to communicate about their stock ideas and strategies to each other in real time.
Once they caught on that GameStop shares were heavily shorted (and therefore were vulnerable to a short squeeze), they bought the stock, effectively forcing many of the short sellers, including large hedge funds, to remove their short positions and buy shares, which then fueled a massive surge in price—and big losses for some hedge funds.
While any major short squeeze would probably gain press attention, this short squeeze was outsized as the stock surged 2,300 percent in just 11 trading sessions. Importantly, this drama exposed a development that had not been widely noticed before—some investors are using digital chat and other internet tools to form stock strategies. This short squeeze involved individual investors, some of whom are new to stock picking.
Winds of digital change
We think the far more important consideration is the root cause of this episode.
From our vantage point, the much bigger phenomenon that’s going on both underneath and above the surface is a megashift within society—the shift into the age of digitization.
The grip that digital technologies now have on day-to-day life has been accelerated by the sudden COVID-19 lockdowns and the tech tools that have facilitated working and living at home nearly 24/7.
This megashift, or period of megachange that some might describe as a new epoch, is not unlike those that occurred during the past 150 years. Think back to the megashift in the late 19th century when the agriculture-based economy transformed into the industrial age, or the megashift in transportation that was brought about by the steam engine and railroad system, or the megashift in international relations that was born out of the ashes of World War II as well as the additional shift after the Soviet Union’s collapse.
These and other megashifts impacted economic, governmental, technological, and cultural trends. They transformed immigration and internal migration patterns, societal norms, religious traditions, and more. They had life-altering and even civilization-altering implications.
Today’s digitization megashift is moving society at lightning speed through the proliferation of artificial intelligence (AI) and digital tracking, the advent of “smart cities,” new personal and business banking technologies, new currency structures (think cryptocurrencies), the convergence of the technology and health care industries, and a myriad of other technologies, some of which even raise ethical and moral dilemmas.
To us, the meme stock chat board phenomenon and greater participation of individual investors in markets are very small outgrowths of the digitization megashift.
Keep your eyes on the long run
What does this mean for investment portfolios?
In the narrow scope of meme stocks and heightened investor communication about stocks and investment strategies, we think digitization will further increase the participation of individual investors in equity markets and that this participation will be more active.
Some individual investors are now more research-oriented, are more focused on individual stocks rather than indexes, and are embracing the options markets. Just like any new investment cycle, some are diligently doing their homework, while others are trying to ride the bull market wave the “easy” way (which rarely works in the long run).
We think the participation of individual investors will grow in number and influence, at least until the next deep and lengthy bear market takes root. In the interim, this doesn’t mean that more GameStop-like episodes will automatically occur and it doesn’t mean they won’t. We don’t count out additional bouts of market volatility related to meme stocks.
There are a number of regulatory issues raised by the GameStop/meme phenomenon, and we think regulators likely will be slow to act. Rule-making authorities tend to be reactive and lag technological innovations and trends. Bloomberg’s regulatory and governmental analysts, for example, believe it could take up to a year for new regulations to emerge that will address this situation, and even then, they doubt there will be sweeping rule changes.
Overall, the meme stock phenomenon is unlikely to have a major impact on traditional, long-term-oriented investment portfolios, in our view. We think the specific episodes and related volatility will come and go.
But the megashift into the digital age is already having a major impact on our lives and we expect this will only accelerate. We think the broader digitization trends and the technological and lifestyle changes they inspire will impact investment portfolios and returns far, far more than the meme stock phenomenon.
This publication has been issued by Royal Bank of Canada on behalf of certain RBC ® companies that form part of the international network of RBC Wealth Management. You should carefully read any risk warnings or regulatory disclosures in this publication or in any other literature accompanying this publication or transmitted to you by Royal Bank of Canada, its affiliates or subsidiaries.
The information contained in this report has been compiled by Royal Bank of Canada and/or its affiliates from sources believed to be reliable, but no representation or warranty, express or implied is made to its accuracy, completeness or correctness. All opinions and estimates contained in this report are judgments as of the date of this report, are subject to change without notice and are provided in good faith but without legal responsibility. This report is not an offer to sell or a solicitation of an offer to buy any securities. Past performance is not a guide to future performance, future returns are not guaranteed, and a loss of original capital may occur. Every province in Canada, state in the U.S. and most countries throughout the world have their own laws regulating the types of securities and other investment products which may be offered to their residents, as well as the process for doing so. As a result, any securities discussed in this report may not be eligible for sale in some jurisdictions. This report is not, and under no circumstances should be construed as, a solicitation to act as a securities broker or dealer in any jurisdiction by any person or company that is not legally permitted to carry on the business of a securities broker or dealer in that jurisdiction. Nothing in this report constitutes legal, accounting or tax advice or individually tailored investment advice.
This material is prepared for general circulation to clients, including clients who are affiliates of Royal Bank of Canada, and does not have regard to the particular circumstances or needs of any specific person who may read it. The investments or services contained in this report may not be suitable for you and it is recommended that you consult an independent investment advisor if you are in doubt about the suitability of such investments or services. To the full extent permitted by law neither Royal Bank of Canada nor any of its affiliates, nor any other person, accepts any liability whatsoever for any direct or consequential loss arising from any use of this report or the information contained herein. No matter contained in this document may be reproduced or copied by any means without the prior consent of Royal Bank of Canada.
Clients of United Kingdom companies may be entitled to compensation from the UK Financial Services Compensation Scheme if any of these entities cannot meet its obligations. This depends on the type of business and the circumstances of the claim. Most types of investment business are covered for up to a total of £85,000. The Channel Island subsidiaries are not covered by the UK Financial Services Compensation Scheme; the offices of Royal Bank of Canada (Channel Islands) Limited in Guernsey and Jersey are covered by the respective compensation schemes in these jurisdictions for deposit taking business only.
Portfolio Advisory Group – U.S.