All that anyone could talk about the other week was the amazing rise in price of GameStop ( GME) stock. This fledgling retailer saw its market capitalization grow to extraordinary heights, some $20 billion in value. The fundamentals of the company would never support anything close to that valuation, but for a moment -- it happened. But the company is near death, so how could this stock rise so much in only a few trading days? Some got rich in a very short time, while some lost substantial sums.
What on earth caused GameStop stock (and others like AMC ( AMC) , Bed Bath & Beyond ( BBBY) ) to take off like a rocket ship? It's a simple imbalance between supply and demand. That is Economics 101. When there is little supply and strong demand, prices will rise to a level until buyers won't pay any longer.
Technically, this is what has been occurring. How does supply suddenly become constrained and demand whipped up? This was a classic short squeeze -- where short sellers are forced to cover their position (buy stock) which creates demand for the stock. Potential buyers see this happen and jump on board, knowing these bearish investors will eventually have to buy at higher price levels if the buyers can push the stock up.
So, this Reddit message board called " Wallstreetbets" puts out some word about buying GameStop. They were wildly bullish, and not for any fundamental reason. After all, the company is falling apart and is probably on its last legs. But that didn't stop the hype machine from going haywire, and some big hedge fund managers with sizeable short positions were hurt badly.
Short squeezes are quite common in markets. Last year saw big squeezes in Kodak ( KODK) and Hertz ( HTZ) for instance, but not as powerful or long in duration. Commodity markets have squeezes all the time, but we never hear much about them. They are nothing more than exploiting an imbalance between demand and supply. The timing of the squeezes is critical, as this one in GameStop and AMC proved. Big short selling managers were complacent and arrogant, never believing they would ever have to lift their short position. They were wrong, once the word got out to buy these shares and they did, it was game on. But now it appears the game is over for GameStop squeeze players.
It's fun to hear the stories and see the headlines hit the news. But this drama was far from reality, and it's starting to settle in. But the idea of trying to punish short sellers for doing what they do best is hardly worth the effort. These squeezes will happen again some day, but don't bet on any of these massive hedge funds who were involved to ever lose sleep over it.
Next week, we will talk about how short selling is a healthy and normal part of market structure.
