Well… that was fast. In two short weeks, GameStop (NYSE:GME) and AMC (NYSE:AMC) stock investors have gone from the new Wall Street kingmakers to naïve newbies. As Reddit-fueled stocks fell back to earth, young Reddit investors watched in dismay as their heat-seeking investments turned to dust. And even before more experienced investors could start their “I told you so” lectures, one thing became clear: Less-experienced investors have already begun drawing the wrong lessons from the fiasco.
Source: Shutterstock / TY Lim
Yes, deep-pocketed hedge funds have won at retail investor expense – Citadel and Point72 will likely walk away with a $2 billion gain this week. But as new investors nurse their meme-stock losses, there’s a great temptation for them to wrongly blame themselves or “the system.” But if that’s not why they lost, then what was?
GME and AMC Stock: The System’s Rigged!
It’s easy to think of Reddit investors as a single person –in the past month, r/WallStreetBets seemed to take on a life of its own. But for every smart (or lucky) soul who bought GameStop under $10, many more on the popular forum spoke of getting in late. These were the investors who paid $100 or more per share — egged on by fellow Redditors with expiring in-the-money call options. (Some of these early birds turned out to be financial professionals moonlighting on Reddit.)
In other words, what started as warranted anger at short-sellers turned into a pump-and-dump by people who knew what they were doing. So, in the end, it was the novice investor who lost the war.
But Who’s to Blame?
Wall Street has mostly watched from the sidelines, leaving novice investors to make mistakes. Bulge-bracket banks vigorously guard their equity research reports, handing them out only to the multi-millionaires and family offices (i.e., the same people who can afford to ignore the advice). And the U.S. education system hasn’t been much better. With its focus on efficient markets and financial theory, most schools don’t prepare people for the possibility of losing 30% of their nest egg in a recession.
That’s why young investors have filled the vacuum for themselves, turning to social media outfits like Reddit to share stories and advice. And it’s no surprise that the echo chamber has created an entire generation of investors who are far more emotional than their predecessors.
These investors are “characterized as having the highest rating for personalization of loss while still having high risk ratings,” explains researchers Ryan Wood and Judith Lynne Zaichkowsky in the Journal of Behavioral Finance. “In other words, this group does not mind taking risks, but feels terrible when they lose money.”
But Really, the System Seems Rigged
In some cases, the Reddit echo chamber got some things right. When Robinhood locked out retail investors from trading high-volatility stocks on Jan. 25, the trading platform might have unintentionally popped the GameStop bubble, sending a lifeline to short-positioned hedge funds. Robinhood CEO Vlad Tenev should expect harsh treatment when he gets grilled by Congress later this month.
But in other cases, the Reddit rumor mill has become a scourge.
“I’m still holding my shares but I don’t expect to see my ~$1200 ever again,” lamented one GameStop investor on Reddit. “Who knows… Maybe it will still go to the moon. I’d be thrilled! But, until then I will hold,” said another latecomer on AMC.
As meme stocks have fallen from their peaks, Redditors have encouraged each other to adopt the “ostrich strategy”: ignore the losses for long enough, and maybe they’ll go away.
Much of this feeling was fueled by others doing the same — and in some cases posting screenshots of doubling down. (Whether all these images are 100% real are up for debate). But the rest of it comes from younger investors’ natural tendency to personify losses. If losing money makes you stupid, then simply never realize those losses. It’s an age-old strategy of short term self-care with long-term costs.
Older investors might view these mental gymnastics with a sense of schadenfreude; all experienced investors have seen their share of battle scars. But this time is different. With the Reddit echo chamber amplifying these practices, these investors risk blaming everyone (including themselves) for their losses and fail to move on.
Wall Street Also Learns the Wrong Lessons
The Reddit machine also has real-world consequences for experienced investors. Consider Andrew Left, CEO of Citron Research. For years, Mr. Left had lambasted Wall Street excesses, reining in corporate behemoths like Valeant for cornering drug markets and pumping prices. His willingness to go against the Wall Street establishment earned him accolades from academics and experienced investors alike.
But then, he made the mistake of calling out GameStop’s absurd valuation right as Reddit investors were getting in. As death threats and random pizza orders showed up at Mr. Left’s door, the respected short-seller vowed never again to publish short-selling research.
Reddit’s chilling effect has since spilled into other areas of finance. Conversations supporting short-selling, an essential mechanism to a well-functioning financial market, has mostly ground to a halt. And investors can probably expect higher premiums the next time they look to transact any meme-potential stock.
Where to Go From Here
Never have so many investors personified stocks as their identity. For these investors, telling them you don’t like Tesla’s stock is almost like spitting in their face. (Older investors, meanwhile, might see Tesla as yet another chit). And the GameStop bubble is cementing the myth that someone’s stock portfolio represents their very character.
Against that backdrop, we’re now faced with a decision. We can choose to say nothing; few want to speak out against the madness of crowds, especially when they can shout back at you.
Or we can keep reaching out and try helping the next generation make sense of the world we’ve built.
After all, millennial investors aren’t going away soon. By 2030, young investors will have inherited $68 trillion, making them one of the most significant financial forces of our time. And if we forget to give them the instruction manual, what does that say about us?
On the date of publication, Tom Yeung did not have (either directly or indirectly) any positions in the securities mentioned in this article.
Tom Yeung, CFA, is a registered investment advisor on a mission to bring simplicity to the world of investing.
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