Letter: A ‘short’ article on irrational investors

How should we assess the GameStop phenomenon?

One could evaluate GameStop as a financial analyst: a declining venture with an outdated business model, a book value below $10, continuing losses and store closures, and a consensus value of somewhere below $15 that suddenly hit $483 at the end of January.

Applying rational choice theory, an economist would assume that investors are seeking and using all available information and making rational decisions based on the costs and benefits of various choices to maximize their outcomes.

But with a stock that briefly traded at more than 3,000% above its fundamentals, it’s easy to claim that investors are being irrational.

There is another possible explanation, though. We’re living in a digital era with fake facts, fake experts, disinformation, politicians who lie with impunity, declining trust in institutions and worsening income inequality. We’re also treated to stories designed to trigger moral outrage, which generates strong responses and clicks, thus selling a lot of ads on social media.

In the case of GameStop, fingers are pointing at a Reddit group known as WallStreetBets for helping to drive up the stock’s price to short-squeeze some hedge funds and punish the 1% for attempting to make a speculative profit.

Perhaps the retail investors are defending the company and the thousands of employees who still work there. But there is also moral outrage lingering from the Occupy Wall Street movement and the lack of meaningful change. This fuels the rage toward hedge funds, billionaires and shadowy insiders perceived to be profiting at the little guy’s expense.

More than just an online spat, the GameStop saga is closer to class warfare. People are using their own hard-earned money rather than just clicks and online insults.

For the hedge funds, the result is a bad month or possibly a bad quarter. For many retail investors, next month’s rent may be at stake. They’ll be left holding millions of shares purchased for hundreds of dollars, and they’ll suffer real — not virtual — losses. In June 2020, a 20-year-old student killed himself because he misunderstood how to calculate his returns on an option-trading strategy through online trading platform Robinhood – the kind of strategy frequently used by WallStreetBets followers to profit from the GameStop volatility. This class warfare is now profoundly serious.

Buying GameStop appears irrational. Some retail investors took what little money they had and jumped on the bandwagon with no idea what was really going on. But other retail investors are more rational than they’re given credit for and may be perfectly willing to lose a few hundred dollars to punish the alleged perpetrators – hedge funds and Wall Street investment banks (and now maybe Robinhood as well). Stuck at home, angry at being socially isolated in an economy that’s mostly shut down, they may think sticking it to the 1% is a wonderful use of their $1,200 Covid stimulus cheque.

Rather than focusing solely on GameStop, there are other important questions. Why is there moral outrage against the financial services industry? What could industry, regulators and policy-makers have done differently? Why is it that only a small minority of people are willing to seek and follow professional financial advice when they’re making complex, risky decisions with potentially life-long consequences? How do we bridge the gap between advisors and the people who need their help? How do we restore trust in our financial markets and institutions?

These questions are becoming more urgent. The Investment Industry Regulatory Organization of Canada reported earlier this month that Canadians opened 2.3 million do-it-yourself accounts in 2020, almost triple the 2019 total. There’s also been a 270% increase in complaints and inquiries regarding these accounts. Some observers see unnerving parallels to the online hype of the dot-com bubble.

We need to answer these questions because this game has very real consequences and this moral outrage will have a real cost.

David Lewis, PhD, CFA, MBA, is the president of the BEworks Research Institute. David has held numerous senior positions at global financial institutions including Barclays Wealth USA, UBS Bank USA, UBS Financial Services Americas, ING DIRECT USA and Bank of Nova Scotia.

Kelly Peters, MBA, is the chief executive officer and co-founder of BEworks. She pioneered the BEworks Method, which is being applied at Global 1000 firms and in policy groups around the world. She held senior positions in strategy and innovation at Royal Bank of Canada, Bank of Montreal and several start-ups. Find her on Twitter and LinkedIn.