Wall Street can’t take its eyes off once-unloved stocks such as
and
which are rocketing due to a kind of betting game played by online forum users. The real risk is that investors start to believe something deeper is going on.
The past year has seen a boom in individuals buying stocks through retail online platforms such as Robinhood. More and more, they seem to be coordinating their moves on sites such as Reddit’s WallStreetBets, placing wagers on firms that are under attack by professional speculators like hedge funds. At Tuesday’s close, GameStop, once a popular target for short sellers, was up almost 3,700% over six months.
There are two main causes of big market moves. The healthier one is when new information comes to light about a company, an industry or the economy at large, and financial assets are repriced to reflect it. The other is when market participants buy or sell in a rush, often because they suddenly need to protect their finances—in which case asset prices don’t convey much useful information.
The latter is at play now. Hedge funds’ short bets have been unsettled, forcing them to buy back the stocks to limit their losses. Also, punters have been using options contracts to prop up their targets. Such instruments can amplify even small market moves, because they force banks to take the other side and then hedge the risk by buying the actual underlying stocks. It can create a feedback loop: Those stocks then go up, and the value of the options tied to them increases even more, forcing banks to hedge further, and so on.
Reddit users haven’t shied away from the technical nature of the price moves, correctly crediting it for their success. But market gyrations caused by bottlenecks in financial plumbing don’t tend to last. The 2018 carnage unleashed by option-driven low-volatility strategies can attest to that. Eventually, there aren’t any forced buyers left. The losses are usually limited in scope.
But often, if something goes up, people have an uncanny ability to convince themselves there is a nontechnical reason for it, creating a self-sustaining narrative. Reddit forums contain some insightful analyses of the value of these companies. After all, perhaps GameStop was somewhat undervalued.
The dot-com bubble of the late 1990s lasted so long partly because many individual investors truly believed innovative business models would eventually justify crazy prices. They weren’t just buying to sell higher. Until recently, high technology-company valuations have mostly been restricted to large solid firms with proven stories, but there are signs of that changing—Tesla and its imitators notably demand faith. While many Reddit users know they are playing a game, they could end up igniting blind enthusiasm for a wider raft of small, unprofitable companies.
So far, Mr. Market seems aware that GameStop’s share price is a meaningless number driven by financial quirks. If he stares at it too long, though, there is a danger that he will start to see real-world prospects.
Write to Jon Sindreu at jon.sindreu@wsj.com
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