A GameStop store in the Manhattan borough of New York City on Jan. 29, 2021.CARLO ALLEGRI/Reuters
The market is having a George Costanza moment.
You will, of course, remember George, the hapless sidekick in Seinfeld. In one key episode of the 1990s sitcom, George realizes his life has consisted of one bad decision after another. His friend Jerry points out the obvious fix: George should begin doing the opposite of whatever his instincts tell him to do.
This strategy works beautifully. In short order, George attracts a beautiful girlfriend and lands a dream job.
If you spot any similarities between George’s do-the-opposite bonanza and today’s big market winners, put up your hand.
The key to making money over the past year has consisted of doing the reverse of whatever common sense or Warren Buffett would suggest. Forget about buying companies with rising profits and strong prospects. The big bucks have gone instead to folks who have loaded up on flawed, unprofitable stocks with uncertain prospects.
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Case in point: the Goldman Sachs Non-Profitable Technology Index, which tracks U.S.-listed companies that operate in innovative sectors and are also losing money.
As you might expect from the name, the Non-Profitables have historically been a poor place to stash your money. Since the pandemic hit, though, they have gone on a rocket ride. From March of last year, they have nearly quintupled in value.
Folks who want to believe markets are efficient can invent tortured explanations for why investors have suddenly fallen in love with money-burning businesses. You can argue, for instance, that the recent lockdowns accelerated the adoption of new technology and thereby boosted tech pioneers that are forgoing profits in favour of growing their businesses.
Does this make sense? Well, maybe. Music streamer Spotify Technology SA , e-commerce retailer Wayfair Inc. and ride-sharer Uber Technologies Inc. are all long-time members of the Non-Profitables. They each have well-seasoned business models with multibillion-dollar revenue streams. So if these companies choose to prioritize rapid growth over profit in a locked-down economy, perhaps that really is a sign of far-sighted management.
The rise of other stocks in the index, though, seems to be more about what happens when you have a lot of bored investors sitting at home with cash in their pockets and an itch to gamble. The result can be an irrational stampede into hot stocks – most notably, anything that has something to do with replacing the internal combustion engine.
Look, for instance, at Plug Power Inc. , the fuel-cell maker, and Nio Inc., the Chinese maker of electric cars. Both of these Non-Profitables are trading at huge multiples of modest revenues, despite considerable uncertainty about their futures. As things now stand, their shares are essentially lottery tickets on the possibility these businesses will turn out to be world-beaters.
But, then, who is to say that this, too, doesn’t stand to reason, at least in a Seinfeldian sense?
If you see today’s market as a rigged game, in which policy makers are deploying huge amounts of cash and low interest rates to push up asset values despite the pandemic, maybe the smart move is to load up on long shots and faint hopes. After all, it is struggling businesses that will get the biggest lift from the outpouring of official support.
A Costanza-like strategy of buying the opposite of good stocks would have played out brilliantly over the past year. Consider the performance of Goldman Sachs’ “most-shorted” index. This benchmark consists of the U.S. stocks that are attracting the greatest amount of “short” interest. Put more simply, they are the ugliest, most unloved companies in the market – the stocks that Wall Street professionals are betting will fall.
Except that this past year they didn’t fall. They more than doubled after the March, 2020, lows. As a result, short-selling hedge funds sustained stinging losses.
The flogging of the short-sellers picked up pace this week with the wild action in the shares of many heavily shorted stocks, notably GameStop Corp. and AMC Entertainment Holdings Inc.
Short sellers had targeted GameStop, a retailer of video games, and AMC, a movie theatre operator, on the assumption that both were operating in wounded industries. But a swarm of retail investors, organized on a Reddit forum, disagreed and kept buying call options on the shares.
Call options give the buyer the right to buy a certain number of shares at a preset price for a specified period. They function like leveraged bets on the stock, magnifying the buying power of the anti-shorts.
A sudden surge of call-option purchases can set off a counterintuitive chain reaction, in which the institutions that sell the call options turn around and buy some of the underlying shares as a way to hedge their exposure in the event the stock winds up rising to the level where the call options will be exercised.
This can help lift the price of the shares and, under the right conditions, can set off a feedback loop in which a rising volume of call options ignites a buying frenzy in the underlying stock, which then leads to even more buying of call options and so on.
None of this has a lot to do with the actual merits of the underlying company. It’s all about the complicated dynamics of the options world, where “gamma hedging” and other Greek-letter confections drive decisions. For that reason, it’s been the subject of much finger-waving by regulators and bystanders.
But how different is it really than the rest of this Seinfeldian market? Non-profitable tech companies have soared to absurd valuations in recent months. So has the newly profitable Tesla Inc. So has bitcoin.
Their rise owes a lot to cheap money, bored investors and idle cash. So long as that combination continues, don’t be surprised to see more and more investors taking their cues from George Costanza, not Warren Buffett.
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