January was filled with some news-worthy Wednesdays. On January 6, the world witnessed the storming of the U.S. Capitol. On January 13, the House of Representatives voted to impeach former president Donald Trump for the second time during his term. On January 20, President Joe Biden became the 46th president. And on January 27, GameStop’s (NYSE:GME) share price opened at $354.83, 139% higher than it closed at the day prior. Since then, GameStop’s share price has reflected a colossal amount of volatility, ranging from a high of $483.00 per share on January 28 to a low of $51.09 per share on February 4.
However, the basis for the burgeoning of the share price lay not in announcements of positive news or in quarterly earnings reports. As NPR’s Jacob Goldstein says on his podcast, Planet Money, the extreme interest in GameStop began back in December 2020, when certain Reddit users on the online forum wallstreetbets noticed sharp increases in GameStop’s share price and realized that the stock remained one of the more heavily shorted stocks by Wall Street. If the share price rose high enough, it could trigger what financial analysts call a short squeeze—and that’s exactly what happened.
When a stock is shorted, the investor is borrowing shares from a brokerage firm, selling them on the market, and buying them back to return to the brokerage firm at a later date. Essentially, the investor believes that the stock is overvalued and that its price will fall in the near future. When the short seller buys the stock back, he or she pockets the difference in price for a profit (or assumes a loss), and the stock is returned to the brokerage firm. Many financial firms did this with GameStop, and they assumed heavy losses.
Once users from wallstreetbets began investing heavily in GameStop, the price shot up due to the volume being traded, and investors holding short positions were forced to either buy back their shorted shares at a loss or add more money into their margin accounts to continue meeting the financial requirements set by their brokerage firms that come with shorting stocks. Of course, when these investors bought their shares back, this pushed GameStop’s share price even higher, causing more short sellers to buy back their shares at a loss. When this occurs, the stock enters a short squeeze period.
The squeeze badly affected hedge funds, most notably Melvin Capital, which lost 53% during January. Volatility in the broader stock market was high in January as shown by the wild fluctuations in the Cboe Volatility Index, or VIX, and other fluctuations in stock market indices. And GameStop is not alone on the list of heavily shorted stocks, which has added to the volatility. Other companies whose share prices have seen sharp increases and decreases over the same period due to similar investment strategies from retail (non-institutional) investors include AMC Entertainment, Blackberry, and Nokia.
Because the underlying fundamentals of these companies do not support the drastically high share prices displayed, it is highly possible that the share prices will fall once more, and retail investors like those on wallstreetbets will be left to bear the brunt of the losses. Over the long term, soaring prices do not follow poor financials. (GameStop’s annual earnings per share for 2020 was $-5.38, and analysts don’t expect the company to make a profit until 2023.) Companies like AMC Entertainment and GameStop have been hit hard by the ongoing COVID-19 pandemic, and great uncertainty remains in the consumer discretionary sector.