GameStop is a Game that Might Not Stop

By John Banks

In 2018, Elon Musk said reality as we know it is probably a simulation.

His basic rationale was that, because the universe is old enough to produce advanced-technology civilizations, there is a high probability those civilizations know how to run advanced computer simulations.

The implication is that life on earth, as you and I know it, is one of those simulations. We are all just characters in an alien version of The Sims (a popular life-simulation video game).

Neil deGrasse Tyson, the celebrated astrophysicist, thinks the simulation hypothesis could be true.

But we are more inclined to agree with Michio Kaku, the celebrated theoretical physicist, who argues that the multi-layered universe is so complex beneath the surface — think quantum physics — that its basic functions are irreducible.

The implication of Kaku’s view is that, in order to simulate the known universe, you would need a computer powerful enough to recreate an actual universe.

And so, if a civilization had that much actual power, they could just crank out real, actual universes, like popping popcorn in the microwave. This makes it likely that our own universe is the real thing.

Sometimes we wonder, though, because reality feels beset by cosmic pranks. If life on earth really is a simulation, whoever is running it seems to like “dad jokes.”

Take the GameStop short squeeze, for example. (We explained the basics on Jan. 26, which you can read about here.)

Just when markets felt like they couldn’t get any crazier, 2021 said “hold my beer.” The whole world is now focused on the GameStop saga.

And it just so happens — this is the cosmic humor part — that the stock getting squeezed has the words “Game and Stop” in its title.

What’s more, the slogan of GameStop, as displayed on its retail signage in dying malls all across America, is “Power to the Players.”

And this is the stock that gets gamed, to such an extreme degree it could make the bigger game — the Wall Street game — completely stop? You can’t make this stuff up.

While the GameStop story was all over the financial news yesterday — even the White House had to acknowledge it — the media is missing just how big this story is.

As of this writing, on the morning of Jan. 28, it looks like the sought-after “infinity squeeze” in GameStop is happening. We don’t know how this ends, but GME could go to $1,000 before this ends. Or even $5,000 or $10,000, you just can’t know.

Giant hedge funds — whose short books are getting vaporized right now, not just in GameStop but a whole suite of names — could wind up collectively losing more in this squeeze than they did in the Volkswagen squeeze of 2008 ($30 billion).

Below are some of the fund loss numbers that were anecdotally reported on Wednesday, Jan. 27.

As you ponder the numbers, keep in mind that the percentage of GameStop shares sold short is still extremely high (because the trapped shorts can’t sell without running the price up further, thus cutting their own throats); that the “infinity squeeze” in GME is still very much ongoing as of this writing; and that the funds below are getting hurt by a roster of skyrocketing short positions (not just GameStop). 

  • SAC Capital, which came into 2021 with an estimated $19 billion in assets under management (AUM), is reportedly 15% down on the month (if not more). Implied loss: $2.85 billion.
  • D1 Capital, which entered 2021 with $20 billion AUM, is reportedly down 20% on the month (if not more). Implied loss: $4 billion.
  • Melvin Capital, which had $12.5 billion, and then received an emergency capital infusion of $2.75 billion, was reportedly down 30% before throwing in the towel on GME. (Whether they are actually out of GME is up for debate; even if they are, they could still be getting killed on other short positions that are hard to unwind.) Implied loss: $3.75 billion.
  • Maplelane Capital, a slightly smaller hedge fund with AUM of $3.5 billion, was reportedly down 33% this month, for an implied loss of $1.1 billion.   

The hedge fund losses noted above (via trading desk scuttlebutt) are nearly $12 billion — and those are just the big names we’ve heard about, and the losses are still ongoing.

GameStop is the main event, but the Reddit army is going after all of the heavily shorted stocks right now. All of them. It is, quite literally, the worst nightmare these giant funds have ever seen.

They can’t just “close their positions” easily because, in the midst of a true squeeze, closing a large short position means sending buy orders into the market for shares that aren’t available to buy (because nobody is selling). That, in turn, makes the share price go up even more.

To get an idea of how widespread the squeeze game has become, Bespoke Investment Group reports that the 30 most heavily shorted stocks on U.S. exchanges, as a basket, were up more than 100% on average.

Not 100% as a basket either — 100% per name.

In some ways the “infinity squeeze” is a very old idea. A hundred years ago they called it “cornering the market.”

If a speculator can corner a market — be it a stock, a commodity, or something else — they can gain such absolute and total control over the available supply that desperate short sellers, along with anyone else who has an obligation to buy, are completely at the speculator’s mercy.

In the 19th century, there was a famous short seller named Daniel Drew, known for his powerful operations on the bearish side of the market.

But Drew made the mistake of messing with Cornelius Vanderbilt, a shrewd railroad tycoon who was even more powerful.

After trapping Drew by cornering the market on shares of the Harlem and Hudson Railroads — and forcing Drew to beg for his financial life — Vanderbilt gleefully repeated one of Drew’s own favorite sayings back to him:

“He who sells what isn’t his’n, must buy it back or go to prison!”

So, that is where many of these giant hedge funds find themselves. They have to “buy it back or go to prison.” But they can’t bid without fueling the fire, and they can’t get their hands on the shares.

If the pressure does not let off soon (very soon), then many of these funds — these gigantic, multi-billion-dollar, “master of the universe” type giants — could die.

There is a joke going around Reddit right now:

Q. How do you become a millionaire?

A. Start out as a billionaire, and then short GME.

The joke is funny because it’s accurate. There are Wall Street billionaires who will no longer be billionaires after this. There are multi-billion-dollar funds that had excellent track records coming into January 2021 that will cease to exist. The high and mighty are being toppled.

You might be wondering, how is this even possible?

How could hedge fund giants and Wall Street titans get laid low by traders on a message board?

The first thing to note is that the Reddit WallStreetBets community, or WSB for short, is not just a run-of-the-mill message board.

Prior to the GameStop story blowing up in the press, the WSB community had roughly 2.2 million members. As of this writing it has 4.4 million members. This means that:

  • The Reddit WSB community more than doubled in size, from 2.2 million members to 4.4 million members, in a matter of days.
  • The largest physical army in the world, the People’s Liberation Army of China, has 2.8 million soldiers. The Reddit army is 57% larger than the PLA.
  • The WSB community is sophisticated in their knowledge of how an “infinity squeeze” works, and what has to be done to corner the market in a stock. They know what to do, and they are doing it. And the size of their community is growing by the minute.

Worse still for the giant hedge funds caught short, the GME short squeeze story has gone global, and retail investors on multiple continents are participating.

There are retail investors in Germany, India, and Australia buying GME. And the number of recruits is swelling due to the nature of social media and algorithmic platforms.

If you type “short squeeze” or “GameStop” into Google or YouTube or TikTok — something millions of people are doing now — you will quickly be served up viral explanations of why the GameStop squeeze is a revolution of the little guy fighting back against Wall Street, and why you should join in.

So, the GameStop story is viral, the GameStop story is global, and the market is structured in such a way that anyone with a brokerage account can participate.

There are people buying a single share of GME, simply to express solidarity with the average joe Redditors in their fight against the big bad hedge funds. (There are also people buying tens of thousands of dollars’ worth of GME and leveraging their buying power with short-dated call options.)

 The GME squeeze is being billed as a profit opportunity — if the stock goes into the thousands, the squeezers will make a killing — but also a protest movement. There is very much an attitude of “the little guy strikes back,” which makes the GME squeeze something of a moral crusade.

That, in turn, adds to the virality of the story, and the willingness of people to buy GME shares and hold them, just to see if they can make a hedge fund die.

Call it revenge for the global financial crisis; revenge for the mortgage crisis; and revenge for connected elites with ivy league pedigrees getting all the breaks in the world, while the average small investor gets none.

The GameStop squeeze has that angry, righteous fire at its core — some are calling it the “real Occupy Wall Street” movement — mixed in with a profit motive for anyone who can buy shares. That is a super-powerful combination.  

For the giant hedges caught in this vice grip, the current state of affairs sounds about as bad as it can possibly get: Trapped like rats by the world’s largest army of angry retail traders, holding fast and buying globally, a kind of 21st century Cornelius Vanderbilt dispersed across a digital swarm.

But no, the story gets even worse for the giant hedge funds. Much worse. 

That is because the WSB community has shown such solidarity and strength in the GME squeeze thus far, other hedge funds are likely to join them.

At this point, the Reddit-centric retail army is probably getting back-up from the hedge fund world itself. Professional firepower has likely joined them.

Not all hedge funds are caught in the short squeeze vice. Some have clean books, meaning, they don’t have any positions that are bleeding them out.

Those funds are now watching the GameStop price action, running their own calculations, and realizing “You know what, this infinity squeeze should actually work. We should join in — on the long side.”

For many hedge funds — those that aren’t bleeding and reeling, that is — contributing to the squeeze is a rational calculation at this point. They are doing the math, and the risk versus reward calculations favor participation if the squeezers can ride along.

Hedge fund managers, after all, are not a monolithic group. They are more than willing to turn on each other, especially when an opportunity for substantial profit is involved.

And when a large hedge fund, or better yet a group of hedge funds, is forced to unwind a losing position, other hedge funds tend to swarm like sharks in a feeding frenzy, or hyenas on a downed wildebeest.

We saw this with the famous multi-billion-dollar meltdown of Long-Term Capital Management (LTCM) in 1998. As LTCM bled out, other hedge funds up and down Wall Street figured out what LTCM’s positions were — and bet against them heavily, knowing LTCM would be forced to capitulate.

What we are witnessing now, in the GameStop infinity squeeze, is truly remarkable. It is something completely old (shades of 18th century Vanderbilt versus Drew) and completely new (a global stock market corner, coordinated by message boards, enabled by zero-commission trading apps, and strengthened through viral messaging).

How is it all going to end? Again, we don’t know. Nobody does. The world has never seen anything like this before. There are historical parallels, of course, but nothing that meets the moment.

The impact on the broader stock market could also be significant.

On Jan. 27 Wall Street had its worst day in three months, for example — with the Dow dropping 633 points — in part because the bleeding hedge fund giants were forced to cut back their long positions.

There is a phenomenon known as “portfolio contagion” that kicks in whenever a big part of the market registers severe losses.

If giant hedge funds are getting hammered in a specific area of their portfolio, they often have to cut risk all across the board, which means reducing position exposure in other areas of the portfolio.

That is why huge losses on the short side can lead to, say, large sell-offs in popular names those same funds were bullish on.

So, there is a real possibility that the GME squeeze could hasten “the end” — as in, the end of this wild bull market — by feeding large-scale sell-offs as giant hedge fund players go into their death throes.

But it’s also possible the broader market shakes this off, and that the game does not, in fact, stop (pun intended). After all, there is another round of stimulus checks coming.

What about the regulators? Isn’t this kind of market manipulation illegal?

That’s a tricky one, because expressing a bullish opinion on a stock is a free speech issue. There is nothing illegal, technically speaking, in deciding to buy shares or call options on a stock you like. There is no inside information, or client privilege, or any of that stuff. Just a bunch of investors on message boards, who all happen to be buying the same stock. 

The Securities and Exchange Commission (SEC) will surely find ways to better regulate options markets after this, and to more effectively detect and dampen coordinated ramp-up activity through actions taken in the market (like more circuit-breakers and halts for stocks deemed in need of a cool-off period).

It’s doubtful the SEC will find traders to prosecute for the GME squeeze, though — which makes sense because, in a funny way, the WSB community is merely doing the same kind of thing hedge funds have been doing, legally, on CNBC for years, in talking up their position in an effort to drum up buy interest.

They took that basic “talk up the stock” approach, made it go viral, and combined it with enough global-buying firepower (and righteous anger) to overwhelm anyone standing in their way.

Another question is whether the game stops after GameStop. Realistically, it might not.

Having tasted the power of unified intent, with a whole smorgasbord of communication apps available, the Reddit army — or whatever one might call it — could constitute a new player on the field, with new soldiers replacing old ones as trading accounts rise and fall.