(CBS Detroit) – The stock market seems to have been acting a little crazy for the most part over the past year. The Dow Jones, the S&P 500 and the NASDAQ have grown steadily despite the COVID pandemic and the resulting economic crisis. The simple explanation is that the continued rise reflects the market’s optimism for a more stable future. A more complicated explanation given the ongoing GameStop saga suggests that there may be more going on.
After bottoming in March, the stock market rose steadily earlier this week. For example, the Dow Jones jumped out of a hole below 19,000 last spring, passed the 30,000 milestone before Thanksgiving, and stayed at 31,000 for most of January. However, the Dow suffered its biggest drop in three months yesterday. The S&P 500 and NASDAQ have followed similar paths.
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Investors value stability. But this time frame was anything but shaped. A runaway virus killed over 420,000 people. The introduction of the vaccine fell far short of the promised values. Record unemployment, which approached 15 percent in April, still remained well above pre-pandemic numbers. An ugly and divisive presidential election produced a controversial outcome and an irritable transition. Finally, a crowd of insurgents invaded the Capitol to keep the lost candidate in power.
At first glance, rising stock values in the face of so much turbulence make no sense. However, two highly effective vaccines have also become available in the past 10 months. Several stimulus packages have helped pump money into a low interest rate and Fed-powered economy poised to stop anything. With Democrats in control of the executive and legislative branches, another stimulus package seems inevitable in the near future. In other words, the end of the pandemic is in sight and an economic bridge is being built to get us there.
As the stock market pays attention to the news, it is reacting to how it will be affected six to twelve months in the future. And at any point after the early days of the pandemic, evidence of a brighter tomorrow has been found.
But maybe there is another reason the stock market is making historic gains during these troubled times. High unemployment has not affected all income groups equally. The unemployment rate among low-wage workers is still around 20 percent, while most high-wage workers have kept their jobs.
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David Kass, clinical professor of finance at the University of Maryland’s Robert H. Smith School of Business, said, “Because people were at home, they couldn’t spend the money on travel, tourism, entertainment, concerts, etc. The money flowed effective in savings. You can’t spend it the way you normally would. Much of the savings went into investments. With interest rates kept close to zero by the Federal Reserve, any investor who, like virtually all investors, wants a positive return is the next best thing to a savings account, CD, or Treasury bill. And the best alternative, a very readily available alternative, is of course the stock exchange that invests in the market. “
“Many millennials, younger investors, opened accounts, for example through Robinhood and other brokerage firms, which in turn stopped charging commissions or fees for trading on the exchange at around the same time,” continued Kass. “So basically a smooth system that encourages investment. Much of the money that could not be spent on the economy because much of it was temporarily shut down would be used for investing in the stock market. “
These individual investors are increasingly optimistic that stocks will continue to rise and are investing accordingly. As noted in a recent New York Times article, this craze is starting to affect the market in general. One example is options trading, which has become popular with small traders.
In the stock options market, people can speculate on whether a stock will go up or down. Those who believe that the price of a stock will go up by a certain day can now get a lower price by buying something called a call option. Until that day they can buy the stock and sell it for a profit.
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The brokerage firm that sold the contract must insure themselves so that they buy some of the stock that they may eventually have to sell. Rising prices lead to more stock purchases, which leads to rising prices. The uptrend in this stock comes from the way the options market works rather than the underlying strength of the company that issued the stock. This chain of events spread across the broader stock market can create a bubble.
The unbridled optimism seems to be particularly boosting the share price of one stock – GameStop. The beleaguered retailer had seen its price crunch, and a customer base increasingly tended to download video games rather than buying the physical version. The company’s share price ended below $ 7 in August and started at $ 17.25 in 2021. Trading ended at $ 345.00 on Wednesday.
Professional investors had sold GameStop stock short for some time. In other words, they sold shares in the company before they owned it. The idea is that they can buy the stocks later when the price has fallen and make a profit. It is generally a risky approach to investing. But bets that the price of GameStop would come down given the company’s future prospects had paid off well. The stock fell for six straight years prior to the last year. The price has risen lately as retail investors have come together to buy and hold more stocks.
The short sellers, which included many hedge funds, take a bath. You must now buy the shares at a higher price to regain your position. And fewer stocks are available. That drives the price even higher. It is commonly referred to as a “short press”.
Part of this twist can be seen as revenge. Short sellers are a little unpopular with investors, and holding onto them can be a point of pride. A certain merit also goes to the growing confidence of the masses in bringing about change. It remains to be seen whether this trust is guaranteed. But day trading, whether it’s short term vengeance or profit, comes with a degree of risk.
Claims about “the intrinsic value of the stock and the importance of GameStop to the gaming industry,” as Bloomberg put it, only go so far. How long can a group of small investors sustain a failing business? GameStop closed hundreds of stores in the past year and lost $ 1.6 billion in the past three years. (Keep in mind that everyone has been stuck indoors and in need of entertainment since last March.) The company is unlikely to turn a profit until 2023. And even that schedule is uncertain, as video game stores appear to be designed to keep track of record stores in the past.
Given the recent volatility in GameStop stock, the price shouldn’t stay high for long. A large-scale sell-off from investors looking to make unforeseen profits could cause it to fall back to earth. GameStop executives could be among them, and they are well rewarded for driving a company into the ground. Regardless, someone will be holding the bag if the stock price falls. And that could very well be the casual, optimistic investor who may not appreciate that what goes up often goes down.
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