Stock Market

The “Reddit Wars” didn’t end when GameStop Corp. (NYSE:GME), movie theater owner AMC Entertainment Holdings Inc. (NYSE:AMC)BlackBerry Ltd. (NYSE:BB), and other online message board favorites crashed in late January.

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In fact, as of late, GameStop is making another huge surge. It’s back up to around $200 after falling from $500 to $60 earlier this year.

Plus, the war has opened on new fronts.

“Normie” retail investors and huge Wall Street institutions aren’t the only ones moving their money from growth stocks to value plays in the past few weeks. The Reddit crowd has targeted heavily shorted media companies that still generate a lot of cash flow.

I’m talking about cable network operators like Discovery Communications Inc. (NASDAQ:DISCA) and AMC Networks Inc. (NASDAQ:AMCX). Both have soared more than 100% since the start of 2021, with most of those gains coming since late February.

Expect more to come.

Whenever the history of the 2020-’21 bull market is finally written, the “Reddit Wars” will capture at least a couple prominent chapters.

Reddit is home to thousands of communities that form organically around specific interests. The community wielding “wild card” impact on the stock market is called “WallStreetBets.”

This community highlights, discusses, and debates specific stocks, as well as various stock market phenomena. Although WallStreetBets was virtually unknown in 2020, it has gained nationwide notoriety as the force that powered GameStop and other stocks shares to stratospheric levels — in the process inflicting billion-dollar losses on a couple of major hedge funds.

For several days in a row in early January, the self-described “degenerates” from WallStreetBets goaded one another to buy as many GameStop shares as possible… and then defiantly clutch those shares with “diamond hands.”

They ended up producing one of the most spectacular short squeezes of all time.

As the video game retailer soared from less than $20 a share to nearly $500, the WallStreetBets folks stripped billions of dollars off the carcass of hedge funds, while piling up billions of dollars of paper gains for themselves.

WallStreetBets became an instant champion of the “little guy” investors who have felt abused for decades by the “Wall Street elite.”

The financial media characterized it as a David-and-Goliath story. But really, Reddit’s brief conquest over short-selling hedge funds was much more a Bonnie-and-Clyde story.

Like the infamous Depression-era bank robbers, the WallStreetBets community became populist folk heroes — who “stole” from the rich and inflicted pain on the establishment.

Unfortunately, just like Bonnie and Clyde, many WallStreetBets investors are now slumped over in the bloody remnants of their portfolios.

The Reddit Army’s War Against “Evil”

After peaking at nearly $500, GameStop shares have collapsed to less than $60 — a harrowing 85% drop that has certainly harmed the WallStreetBets crowd and torched about $30 billion of their paper profits.

While GameStop has made a comeback, future campaigns against the elite may be more difficult to wage. Nevertheless, the Reddit Wars have produced a fascinating glimpse into a new stock market influence.

Let’s call it “democratized investing.”

You see, the WallStreetBets community members are not typical greed-driven day traders. Making money is important, of course. But that’s just one part of the ethos that animates their “hive mind.”

A sense of egalitarian camaraderie and class “justice” also motivates their behavior. They esteem, praise, and encourage devotion to a united cause — like making short sellers pay for betting against their beloved GameStop.

For the WallStreetBets folks, betting against GameStop is a kind of sacrilege. It feels to them as if someone is betting against their fondest childhood memory. It feels kind of evil.

This perspective motivated the Reddit Army to wage war against “elitist” billionaire short sellers and to inflict as much pain as possible.

For a brief moment, this army won a few battles against the short sellers and became a front-page sensation. Like never before, investors of all types are able to exchange ideas freely and publicly, and then organize around those ideas to flash-buy specific stocks like GameStop.

This form of “democratized” investing is a new phenomenon.

But the mob psychology and “animal spirits” it has been fostering are not new at all. Neither is the resulting disregard for traditional investment processes and risk-reward calculations.

Generation after generation, investor “mobs” form … and then rip through the stock market to produce wild speculative extremes.

Again, this phenomenon isn’t new. It is at least as old as Holland’s “tulip bulb mania” of the early 1600s. This fascinating tale of excess featured a multiyear speculative frenzy for exotic tulip bulbs that topped out in 1637.

At the peak of the mania, a single bulb changed hands for 5,200 florins, which was more than three times what Rembrandt charged for painting “The Night Watch” just five years later.

According to Mike Dash, who wrote Tulipomania: The Story of the World’s Most Coveted Flower & the Extraordinary Passions It Aroused:

[5,200 florins] was sufficient to purchase one of the grandest homes on the most fashionable canal in Amsterdam for cash, complete with a coach house and a [small] garden — and this at a time when homes in that city were as expensive as property anywhere in the world.

This particular comparison is not merely theoretical. Earlier in the tulip mania, the owner of a prime townhouse in Amsterdam offered to exchange it for 10 bulbs of the coveted Semper Augustus.

Sound far-fetched? That identical history repeated earlier this year, when 1,000 shares of GameStop temporarily soared to more than the median value of an American home.

Manias are fun while they last. Lots of fun. But they tend to create a big mess when they end.

When stocks imploded in 2000 and 2001, the collapse that ensued wasn’t just a “ thing.” The entire stock market tanked.

That’s a typical consequence of a speculative mania. They are dangerous to all market participants.

Which brings us back around to our current stock market condition.

Be Aware … but Don’t Fear

Are we in the midst of bubble-type conditions? Should we be concerned?

The short but unhelpful answer is, “Probably so.” We should be concerned … but not terrified.

The Reddit Army’s recent stock market feats are not merely an egalitarian triumph of the “little guy” over the entrenched elite. They also represent a triumph of sheer blind passion over fundamental investment insight. That is the “bubble” part of the story — the worrisome part.

No two speculative bubbles are identical, of course, but they all share one specific trait: indifference to traditional assessments of value.

Speculative assets break free from their moorings to any rational valuation and begin drifting on a volatile and unpredictable sea of emotion and fantastical expectations.

In most stock market phases, fundamentals-based investment strategies hold sway. Using timeworn analytical tools and valuation metrics, we invest in stocks that offer some plausible version of GARP — growth at a reasonable price.

We might quibble about what constitutes a “reasonable” price valuation, but generally agree that price matters.

A “growthy” investor might be comfortable paying 30 times earnings, while a “value” investor might want to pay no more than 15 times earnings.

During bull markets, however, the rules change.

Early in the cycle, uber-bullish investors might embrace “edgy” investment tactics like buying stocks that trade at 50 times earnings… or even 100 times. They might assert that 50 times or 100 times is “cheap,” relative to a specific company’s growth prospects.

After all, investors who paid 50 times earnings for Nvidia Corp. (NASDAQ:NVDA) shares last March would have doubled their money by now… and investors who paid 75 times earnings for Enphase Energy Inc. (NASDAQ:ENPH) shares last May would have reaped a gain of more than 300%.

Even the folks who paid 100 times earnings for Inc. (NASDAQ:AMZN) shares last spring would have made more than 65%!

Late in a bull-market cycle, however, optimistic investors do not merely bend the rules. They discard them entirely.

Rather than shackling themselves to the constraints of traditional securities analysis, these investors embrace an analytical Woodstock of free association, feel-good vibes, short-termism, and results-based “truth.”

So what does this new WallStreetBets influence mean for “old school” investors? Maybe nothing. Or maybe it means that we should at least acknowledge its potential impact.

We should be aware of this crowd, mark its location, and steer clear, much like you would do with a beehive.

But WallStreetBets does not pose a systemic risk that matters. It doesn’t warrant new regulations.

The folks from WallStreetBets, and the short sellers who oppose them, are simply investors who are taking risks. Some of those risks will achieve a commensurate reward, and some of them won’t.

Remember, investing is optional. Always has been, always will be.

But once investors decide to pursue that option, they agree to the rules of the game, which means they might win … or they might lose. And the bigger the risk they take — like taking either side of a volatile stock like GameStop — the more likely they are to win big… or lose big.

Every investor has the option to engage in low-risk behavior or high-risk behavior.

It’s optional.

I’ve never owned a single share of GameStop. Nor have I shorted one. Not because I fail to understand how much money I could make in a matter of minutes, but rather because I fear how much money I could lose in a matter of minutes.

That trade isn’t my cup of tea, but I don’t care that someone else wants to give it a try. That’s called a “free market”… and it isn’t something to fear.

Tomorrow, I plan to release the new issue of Fry’s Investment Report. Along with updates on the megatrends I’m following, I plan to make a new recommendation.

It won’t be risk-free. But I believe the rewards will be larger and longer lasting than this week’s sparkly object.

Find out how to join us here.

On the date of publication, Eric Fry did not have (either directly or indirectly) any positions in the securities mentioned in this article.

Eric Fry is an award-winning stock picker with numerous “10-bagger” calls — in good markets AND bad. How? By finding potent global megatrends … before they take off. And when it comes to bear markets, you’ll want to have his “blueprint” in hand before stocks go south.