David Beats Goliath

Novice Traders Take Down Wall Street Were you forwarded this email? [Sign-up to The Daily Reckoning here.]( [Unsubscribe]( [Daily Reckoning] David Beats Goliath - The stock of a money-losing company spikes 1,600% in a single month… - Minnow investors harpoon the hedge fund whales… - Then Dan Amoss shows you why the “Fed put” explains the insane GameStop saga… Recommended Link [Ready for Another March-Style Market Crash?]( [Read more here...]( This critical crash prep message is time-sensitive and controversial. It contains a mysterious crash preparation technique that you won’t find on Google, Bing, Youtube, or any other search engine or website. Please do NOT forward or share this opportunity with anyone else. Viewers discretion advised. [Go Here To Learn More]( Annapolis, Maryland January 29, 2021 [Brian Maher] Dear Reader, We sense we are among unrealities... Joe Biden is president of the United States, Donald Trump was president of the United States… The director of the National Institute of Allergy and Infectious Diseases is famous… Washington and Lincoln are infamous... And a fifth-rate stock that trades for $17 on January 4 trades for $469 on January 28. In what world could it come to pass? Surely the clocks run backward. Ice is aflame. The sun dawns in the west and dusks in the east. GameStop is a “brick-and-mortar” retailer of video games and related merchandise. Like many retailers, it confronts savage competition from digital rivals. Its business model is obsolete. Why visit the store when you can simply download your entertainment? The company is losing money. Yet its stock has gone skyshooting over 1,600% this month. Its chief executive officer is presently worth $1 billion… though he captains a sinking vessel. You are likely aware of the mania at this point. Flush hedge funds had “shorted” GameStop stock, expecting to profit when its price dropped. But a collection of some five million day traders on a Reddit forum — WallStreetBets by name — tossed a spanner in the works. Most own accounts with small balances… generally under $5,000. They are, in the parlance of the trade, “newbies.” These saboteurs piled into GameStop stock in astounding volume. This mass purchasing sent the stock price galloping higher. The short-selling hedge funds began hemorrhaging sweat. The higher the price jumped, the more money they would lose. We will not descend into the witchcraft of options trading. It can be complicated. And we are versed only in its merest rudiments. But this you must understand: When you short a stock, you must borrow it from a broker. You then sell it upon the open market. To exit your position at a later date, you must repurchase the stock… and return it to the broker. If the stock declines — as you had planned — you reap a profit. If the stock increases, you endure a loss. The higher the stock price, the more money you lose. You, therefore, prefer an early exit. You would rather lose some than lose much. But recall, you must repurchase the stock to exit your position. If many short-sellers purchase the stock, it pushes the stock higher still. Other short-sellers then capitulate… and exit their position… meaning they purchase more shares… pushing prices higher yet. Now come back to GameStop… The small fry traders of WallStreetBets gobbled loads of GameStop stock. That, of course, placed upward pressure upon the price. The flummoxed hedge funds began exiting their short positions to avoid further losses. That is, they were forced to purchase GameStop stock. Thus the stock price increased. The billiard balls were set in dizzying motion… more short-sellers being “squeezed” from their positions… the more stock they were forced to purchase… the higher the stock price. Before you know what has struck you, GameStop stock streaked from $17 to $469 within one month. Impossible — but there you are. Thus the day trading minnows harpoon the mighty hedge fund whales. GameStop trades today at $323, not $469. It is plenty handsome nonetheless. WallStreetBets members reaped windfall fortunes. Many are now in clover… at least until they squander it all chasing the next rainbow. In all, they squeezed $20 billion from the short-sellers this month. And so the gold rush is on… Some two million new members stampeded into WallStreetBets yesterday alone. Each seeks his fortune in the new wild west. “Go long shorted stocks, young man.” Most will come to grief of course… prospectors plumbing dry river beds. Here you have the bubble psychology in all its fevered delirium, all its dizziness. How much longer it can rage we do not know. Richard Fisher — former president of the Dallas Federal Reserve — is gravely concerned: I think we've had a bubble for some time. This is just icing on the cake. When things get out of control like this, it is a sign that you should be very worried. They have seen the rich get extremely rich by taking advantage of cheap money — and they want to get their piece as well. This is a sign that we are getting a blow-off top. What you're doing is throwing money out there — and hoping to find an idea. It's another indicator that money is too cheap. But why, Mr. Fisher, is money too cheap? Perhaps because your former institution has pummeled it to nothing? A drug peddler gives away his narcotics in order to hook customers. It is the first intoxication for many. He hooks them. Before long they are addicted, bankrupted and ruined. He then scolds them for accepting his offer. Now you have the flavor of it. For now, the dealer still pushes his drugs… and many of his addicts are heading for the gutter… Below, Jim Rickards’ senior analyst, Dan Amoss, takes you for a fascinating journey with GameStop and shows you why it’s a classic example of the “Fed put” in action. Read on. Regards, [Brian Maher] Brian Maher Managing Editor, The Daily Reckoning Editor’s note: Are you really prepared for Joe Biden’s presidency? Many investors aren’t. Don’t be one of them... [Click here for more...]( All the new money printing and debt that's accumulated over the past few years is staggering. But it’s just the beginning. With big-spending Democrats in control of the White House and Congress, spending and debt will go through the roof. [There's absolutely no doubt that the next few years are going to see massive transformations to our financial system.]( Which is why Porter Stansberry, Founder of Stansberry Research, says there are [3 critical steps every American must take]( with his or her money, starting immediately. You don't have to pay a penny to hear Porter explain more about all three steps. Just take a few minutes to check out his presentation on the subject, [right here.]( Recommended Link [A stock that yields 69% a year? Really?]( [Read more here...]( In today’s helter-skelter market, most investors would be happy with stocks yielding 4% or 5%. But they’d be setting their sights too low. Because I’ve built a portfolio that pays us a 69% cash on cash return — with no leverage, options, or gimmicks. [Get The Full Story Here]( The Daily Reckoning Presents: Anatomy of a bubble… ****************************** Irrational Exuberance By Dan Amoss [Dan Amoss]Today we’re seeing recklessly bullish trading behavior. An extreme example of reckless trading is the bubble in GameStop Corp. (GME), a dying mall-based retailer of video games. It’s bound to become obsolete in a digital video gaming world. Revenue has been shrinking consistently for years as video gamers switch from games bought in physical stores to games downloaded directly from the internet. GME is, for now, a trader favorite because it has a high short interest. Just as a reminder, when you short a stock, you’re betting the price will fall. Short interest is the amount of stock that has been sold short but hasn't been closed out yet (more details below). High short interest shows investors are very pessimistic about the stock. Young, phone-app-based traders are constantly scanning chat forums for hot trends. When you read some of the comments in these chat forums, it’s clear that momentum is the only factor driving trading in GME. Markets are less liquid than people seem to realize. The new traders buying out-of-the-money call options on GME think they have the collective power to push the stock where they want it to go. In an out-of-the-money call option, the stock price is less than its strike price (the price at which the owner of the option can buy or sell the underlying stock). For example, if a stock is trading at $10, any strike above $10 is considered out-of-the-money. But these new traders don’t have the power to push the stock where they want to go. Let’s cover some basics of what’s going on… When you short a stock, you borrow shares from a broker, sell the shares, then repurchase them to return to your broker. To close out your position, you have to actually buy the shares. If the stock drops after you initially sell it, you buy it back at a lower price and return it to your broker. The difference between the sell price and the buy price is the profit. For example, if you short 100 shares of a stock trading at $10 and sell it when it drops to $1, when you return the shares to your broker, you pocket a $900 profit. The problem is, if the stock price increases, then you lose money. For example, if the $10 stock goes to $20, you lose big. And the higher the stock goes, the more you lose. Your losses are potentially infinite because there’s no limit to how high the stock price could go. In order to cut your losses and exit your position before you lose even more money, you need to buy back the shares and return them to the broker. It’s called a short squeeze because short-sellers are squeezed out of their positions. When a lot of short-sellers buy the stock back, that only drives up the stock price further. It can result in a dramatic price spike, like we’ve seen with GME. The abrupt imbalance in supply and demand causes the share price to spike violently. The key takeaway is that mass purchases of out-of-the-money, short-dated call options have the effect of multiplying demand for a stock (over the very short term) by several-fold. But it can all reverse in a heartbeat. The surge in demand for the stock is only temporary. These traders have no intention of buying and holding GME. Once this episode is over, someone will need to hold each issued share of GME, and that holder is likely to mentally associate the share price with trends at the underlying business. There’s a reason why GME attracted so much short interest in the first place. It’s a dying business. This manic episode in GameStop makes one wonder… what thought processes and emotions explain this behavior? Explanations like greed, lockdown boredom, and zero trading commissions are unsatisfying. The best explanation, in my view, is that years of easy Federal Reserve policy and dip buying have led to a mass delusion that the Fed won’t let stocks fall (at least very much). This is the so-called “Fed put.” In this belief system, investors can go hog wild taking risks because they can ultimately “put” their shares to the Fed, which has implicitly written a put option on the stock market. Well, one day, the "Fed put" will be harshly tested, and the Fed may feel obligated to step up and buy stocks. Only when the time comes, the Fed might be limited in the actions it can take because so many of its goals conflict with each other: - supporting the stock market; - defending the U.S. dollar from a crisis in confidence; and - continuing to fund the U.S. budget deficit (“Shh! It’s not monetization of the debt!”). Recommended Link [Ex-CIA Insider: This is Biden's Next Crisis]( [Read more here...]( If you're pinning your hopes on Joe Biden... Or you've got your cash ready for a post-pandemic recovery... I'm afraid I've got some bad news. Because I've uncovered something that should have Joe, Kamala, and the rest of their new White House team quaking in their boots. It's a credible threat to every financial recover "plan" they've got. And a high potential risk for regular investors too. You'll want to see this. [Click Here To Learn More]( It’s no secret that the Federal Reserve has become increasingly sensitive to stock price movements. It took an extreme reputational risk with the programs unveiled in March 2020, which were arguably illegal. That’s how badly the Fed wanted to stop the liquidation of risky assets at the height of the panic. Thus far, the Fed has only had to support the corporate bond market. Higher bond prices have, in turn, supported the stock prices of leveraged companies. And here, the Fed has only had to tiptoe into the market. Its mere threat of epic corporate bond purchases triggered a remarkable rebound in prices and decline in yields (bond prices and bond yields move in opposite directions). Like any successful manipulation campaign, the Fed had market participants take its desired actions without having to take action itself. Ever since that eventful month of March 2020, the supply of new corporate bonds and stock shares has exploded higher. Every one of these new securities must find a buyer willing to buy and hold — not just buy and flip. There is plenty of newly printed cash floating around. Much of it is flowing from government budget deficits, not new bank loans. Some of this cash (“stimmy checks,” as the kids call it) is looking for an asset that doesn’t yield zero percent. Punting on GME call options, which have no connection to the underlying business, are deemed a fine substitute for sports betting. We’re left with a situation in which inefficient, money-losing companies like GameStop, cash-burning “story stocks,” and corporate zombies are polluting the capital markets with more and more stock and bond offerings of dubious quality. The longer this phenomenon goes on, the more polluted the markets will become. Even if the underlying companies are high-quality, if their stocks and bonds are priced at absurdly high valuations, they can become very bad investments. Will initial buyers of these securities hold onto them when the momentum tide eventually turns? It’s very doubtful. They’ll look for someone else to dump them onto. Such are the consequences of stocks becoming wildly disconnected from fundamentals like revenues, earnings and cash flows. Once momentum turns lower, the path lower to reconnect with fundamental support could be a crash. The reward for buying and holding a stock is ultimately the stream of dividends it can pay to its owner. Many stocks go to zero before ever paying a dividend and are just flipped from one trader to the next for their entire trading history. Other stocks, like the popular Big Tech names, are currently priced in anticipation of massive dividends ten or twenty years down the road. And there’s not much critical thinking going on about how likely it is that Big Tech will all, as a group, be swimming in sufficient free cash flow to enable the payout of such highly anticipated future dividends. Would the Fed step in to buy stocks if we see an abrupt reversal in the desire to hold bubble stocks? It remains to be seen. Other central banks who’ve bought stocks in recent years have limited purchases to ETFs and large-cap blue-chip names that are likely to be around for a long time. If we see more central bank buying in the future, it would be one more way that they could lose control of the size of their balance sheets. Central banks cannot be all things to all people. They can’t make everyone happy and wealthy. What they have proven to do well is promote conditions that cause reckless behavior in stocks like GameStop, while deflecting blame on other factors. They’ve also done a fabulous job in magnifying wealth inequality. In the years ahead, more investors will recognize that the Fed and other central banks have boxed themselves into positions of having to support corporate bonds, stocks, government bonds and government budgets — all while preventing a collapse in confidence in the currencies they manage. Central banks are powerful, but they’re not deities. At this point, it’s clear that central banks are least worried about maintaining confidence in the currencies they manage. The Fed will take radical action in response to the next big stock market correction, and the results will be painful for the increasingly abused sanctity of the U.S. dollar. Precious metals, including gold and silver, will get another substantial boost in this scenario. Regards, Dan Amoss for The Daily Reckoning Editor’s note: Are you really prepared for Joe Biden’s presidency? Many investors aren’t. Don’t be one of them... [Click here for more...]( All the new money printing and debt that's accumulated over the past few years is staggering. But it’s just the beginning. With big-spending Democrats in control of the White House and Congress, spending and debt will go through the roof. [There's absolutely no doubt that the next few years are going to see massive transformations to our financial system.]( Which is why Porter Stansberry, Founder of Stansberry Research, says there are [3 critical steps every American must take]( with his or her money, starting immediately. You don't have to pay a penny to hear Porter explain more about all three steps. Just take a few minutes to check out his presentation on the subject, [right here.]( --------------------------------------------------------------- Thank you for reading The Daily Reckoning! We greatly value your questions and comments. Please send all feedback to [feedback@dailyreckoning.com.](mailto:dr@dailyreckoning.com) [Dan Amoss]Previously the investment adviser to one of the top small-cap mutual funds in the country, Dan Amoss is a senior investment analyst and CFA at Agora Financial. Dan tracks aggressive accounting and other red flags that markets miss as he exposes frauds and promotions that suck in unsuspecting investors. His bottom-up investing style focuses on management strategy, return on capital and the truth (and lies) buried in financial statements. Add feedback@dailyreckoning.com to your address book: [Whitelist us]( Additional Articles & Commentary: [Daily Reckoning Website]( Join the conversation! Follow us on social media: [Facebook]( [LinkedIn]( [Twitter]( [RSS Feed]( [YouTube]( The Daily Reckoning is committed to protecting and respecting your privacy. We do not rent or share your email address. 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