Iron Capital Insights

  • Iron Capital Insights
  • January 31, 2021
  • Chuck Osborne

The Games Children Play

The spectacle of modern investment markets has sometimes moved me towards the conclusion that to make the purchase of an investment permanent and indissoluble, like marriage, except by reason of death or other grave cause, might be a useful remedy for our contemporary evils. For this would force the investor to direct his mind to the long-term prospects and to those only.
~ John Maynard Keynes, “The General Theory of Employment, Interest and Money”

I have to tell the truth: I wish I were writing about almost anything else. I find last week’s big story regarding Gamestop and the battle between young, inexperienced hedge fund traders and young, inexperienced day traders a boring distraction from real investing. I share this quote from Keynes as a testament to the fact that if one believes that this is somehow new or unprecedented, then he is gravely mistaken. In fact, I am going to go out on a limb here and say that regardless the subject, if one believes something is truly new, she is wrong. There have been approximately 4,000 years of human history. Whatever it is, it’s been done before. The only thing unprecedented about our era is that we now have too much free time to obsess on the trivial. But I digress.

The story of Gamestop is not complicated. Gamestop sells video games and gaming merchandise much the way Blockbuster used to rent movies. Its future, unless it can completely reinvent itself, is to follow the path of so many companies before into oblivion; to become an answer to trivia questions, and one day be highlighted in a movie where some kid goes back in time.

With this in mind it is certainly a company whose stock should be sold – and sold it was, by not only those who owned it, but also those who did not own it, the short sellers. Here is where a major regulatory disfunction becomes highlighted, once again I might add. To sell short (which is the term used to describe selling a stock one does not own), investors used to have to wait until some other investor bought the stock and caused the price to move higher. This was called the uptick rule, and was the way short selling worked from 1938 until 2007 when the SEC, in their infinite wisdom, removed the rule, and … well, do you remember 2008?

In 2010 the SEC wrote a new, watered down, far-too-complicated (which is another way of saying it’s easy to get around) version. Since then, short sellers have given us the flash bear market in 2018 and last year’s road to misery. The problem, in terms of fixing this, is that the impacts are short-lived and they actually create opportunities for longer term investors. We bounced back very well in both of those cases.

What is less noticeable to lay investors are the micro-disconnections that occur on individual stocks often. We see this almost all the time; there is a compounding effect whereby most hedge fund trading today is run by computer models and all the models are the same, so every professional trader is on the same side of all of these trades, and the daily volatility on individual stocks is hugely amplified.

Some day traders (that’s what we called them when I was their age, so that is what I’m going to call them) figured this out and saw an opportunity. The rest of the story is just color; this is the essence of what has happened. Is it a problem? Not really, but to the extent it is a problem, it is all due to the fact that the SEC has allowed short sellers to run amuck for more than a decade now. Bring back the uptick rule and this story goes away.

For the rest of us, times like this are a good reminder of why we invest prudently. We are owners of companies, not traders of stocks. These things do not happen to quality companies with solid futures. We are bottom-up investors; we invest in companies, not the “stock market.” The market is exactly what its name says, a market. I don’t care if they are price gouging on Captain Crunch, I’m buying eggs and bacon because we eat a real breakfast and the prices for eggs and bacon are fair.

We are absolute return-oriented. In other words, we do not participate in competitive investing. If some day trader made a lot of money on Gamestop, then good for her. That does not hurt me in the least. If some hedge fund rookie trader loses his boss a lot of money, well, welcome to Wall Street. These things do not impact us in the least, except that the time I spend thinking about this is time I can’t use finding actual investments.

We are risk-averse. While I put all the blame, if that is even the right word, for this fiasco on the short selling culture, this day trading trend will not end well. Those who make a lot fast, lose a lot fast. Las Vegas wasn’t built because gamblers are successful. There is a brass card holder and clock on my desk which I refer to as my “Purple Heart.” The last time we had a day trading craze, the technology required serious traders to come to offices where they could access trading terminals. One such place was down the hall from my office when I was a young team leader at what was then Aetna Retirement and is now part of Voya. One of those traders lost everything. In his desperation he took a gun, killed his wife and children, then came to our building. He killed several people that day, and my team members saved the life of one of his victims who was shot in the back. He eventually committed what they call suicide by cop, forcing the police to shoot him. Our bosses at Aetna Retirement came to Atlanta, took us to an expensive lunch, and gave us those card holders – our “Purple Hearts.”

Those who do not learn their history are doomed to repeat it. Trust me, there is nothing new, and nothing good, in this Gamestop story. This will not end well for any who get involved.

Warm regards,

Chuck Osborne, CFA
Managing Director