Lessons from the GameStop story – ‘It will, I fear, be the small investors who are most badly burnt’

Something will end this bull market. I personally expect that to be a rise in inflation, and hence of interest rates, writes Hamish McRae

The GameStop story represents a victory of Main Street over Wall Street – but there may yet be a sting in the tail (Getty)

There are some troubling lessons from the amazing GameStop saga that go far beyond America. But thay may not be the ones you would think.  

If you are not familiar with the story, there is an excellent account by my colleague Ben Chapman here. It is, he writes, how “a battle between an army of amateur investors and multibillion-dollar hedge funds has ignited a trading frenzy, sending the share prices of some previously unfancied companies surging while delivering a kicking to the short sellers who bet against them”.  

The story came to a head over GameStop, which was a struggling video games retailer, hit by the pandemic. As a result, its shares had been shorted by professional investors. Small investors united under a Reddit forum piled in, the price shot up, and in that lovely market phrase, the bears had to run for cover. The short sellers had to close out their contracts by buying back shares at an inflated price, losing a ton of money as they did so. So this is victory for the little guys – hurrah! – a victory of Main Street over Wall Street, and a demonstration of the way in which social media gives power to the people.  

In a way it is a bit like crowdfunding. An investment project does not qualify for raising money from the conventional sources. So people make their pitch on social media, and if that pitch is convincing enough, they raise the cash directly. There were apparently seven new equity crowdfunding offerings in the US last week. Brilliant – except that around 90 per cent of start-ups fail. 

That leads to the first lesson from the GameStop story. Retail investors can sometimes outwit the professionals, but it requires a huge amount of detailed work to do so. You may be lucky, as investors in GameStop were. But for long-term success you have to do the research. That means knowing the market for the goods and services on offer, studying the track record of the management, and unpicking the company’s finances.

In the UK you have to know what to look for in the returns filed at Companies House. Hint: check out the record of the directors. If they have been associated with any company that has gone belly up, don’t touch the project, however beguiling it might seem.  

The second lesson is that this is a massively frothy market. Look at what has happened to Bitcoin, or indeed the share price of Tesla. Bull markets suck in novice investors. At the moment they are reading stories of people who have made millions by buying some high-tech company before it became fashionable, and they want to get in on the act. Technology makes that much easier than before. But they fail to remember the famous adage of the Sage of Omaha, Warren Buffett, that they should be “fearful when others are greedy, and greedy when others are fearful”.  

I actually prefer the rather similar principle that investors should not be too greedy at all. The banker JP Morgan once said: “I made a fortune getting out too soon.” And Baron Nathan Rothschild’s version of the same thought was: “I never buy at the bottom and I always sell too soon.”  

I suppose what worries me is that the current frenzy of retail buyers in the market, and the GameStop tale in particular, will come to be seen as one of those early signals of a turning point in market mood. It could be a bit like the run on Northern Rock in 2007, the effects of which last through to today. Those pictures of people outside branches queuing to get their money out were a full year before the real financial crash, with the collapse of Lehman Brothers.  

This is not to suggest there will be another financial crash, though no one should ever rule that out. It is simply that this is a period of excess in financial markets, and GameStop is one of many signs of that. Something will end this bull market. I personally expect that to be a rise in inflation, and hence of interest rates. And when that happens it will, I fear, be the small investors who are most badly burnt.