Wall Street endured a wild ride last week. The highlight was shares of GameStop (GME) jumping more than 400% as coordinated retail investor buying prompted panicked short-covering by hedge funds. Many hedge funds suffered spectacular losses as a result. It seems fitting (and a humorous irony) that the small investors who savaged the elites used the online Robinhood trading platform. We’re not making this up!
The turmoil was unusual, but not unprecedented. We’ve been here before. Market history is full of examples of massive “short squeeze” rallies in stocks that had been decimated. But these have typically been fleeting, and the stock ultimately crashes again. These latest, like GameStop, are unique in that they have been turbocharged by a few specific factors, including free options trading and social media coordination, which accelerated forced buying (brokers hedging calls, shorts covering) this time around.
Despite these distinct circumstances, one thing seems certain: eventually, the forced buying runs its course. Then what? It’s not as though long-term investors start buying; T. Rowe Price doesn’t pick up where Melvin Capital left off. These stocks will eventually be much lower – catastrophically lower – as they once again reflect bad business conditions. So, last week’s commotion isn’t a “new way of thinking” that upends long-term investing. It is useful reminder of how risky short-selling can be. Your premise can be correct long-term (i.e. GameStop has serious business problems) but still get crushed short-term. We believe long-term investing will usually provide greater returns and lower risk, which is why Bartlett doesn’t practice short-selling.
The latest volatility reinforces the importance of carefully reviewing portfolios and making sure risk management safeguards are always up-to-date. These include asset allocation, diversification, and careful planning for anticipated withdrawals. Paraphrasing Waren Buffett, we should all be more circumspect when others are getting more adventurous.