Morningstar - Q2 2021 - 11

The Stock Market Is
Strictly Business
And the little guy is
doing just fine.

IVORY TOWERS

John Rekenthaler

Although the magnitude of the rise startled
me-the stock gained 2,500% in two
weeks-the surge of GameStop GME in January
was not otherwise remarkable. Individual investors
have been in a mood since the coronavirus
shutdown, as was evidenced by, among other
items, the rise of Tesla TSLA, Peloton PTON,
and bitcoin. Enthusiasm reigns.
Broadly speaking, today's market climate
resembles that of the late 1990s. Then,
too, upcoming individual investors were aggressive,
trading Internet stocks from accounts they had
established within discount brokerage firms. They
also brandished their youth as a virtue,
believing that they understood technology better
than did their stodgy elders. (Likely true.)
Their behavior was isolated because there
was no practical method for uniting them. Thus,
while the underlying conditions for the
two eras are similar-a rising investor class that
sought to push aside its predecessors-
the outcome has been different. Thanks to social
media, today's Young Investment Turks are
organized. They use the power of their numbers
to force market prices to obey their will.
No laws prevent people from sharing
investment ideas (provided they don't conspire
to manipulate the stock's price). Quite the
contrary; the Investment Company Act of 1940 was
enacted so that shareholders could do just
that. More to the point, investment clubs have
historically served the same function,
but in nonregulated fashion. The Reddit forum

WallStreetBets, which kicked off the GameStop
frenzy, is in effect a virtual investment club.
It is, however, an investment club with attitude.
WSB readers bought GameStop for two
reasons. One was profit. Because the company's
stock had been heavily shorted, a steep rise
in its price, which WSB investors could generate
by buying GameStop en masse, would lead
to an even greater gain after those short sellers
became squeezed. The second motive was
morality. Not only could GameStop buyers punish
short sellers, but the rally would also damage
hedge funds, which held most of those short
positions. Win-win.
Morality Play?

This narrative surprises me, because until recently,
short sellers were popular heroes. In December
2015, the movie The Big Short debuted
to both critical and popular acclaim. Among the
film's leads was Dr. Michael Burry, portrayed by
Christian Bale, who shorted collateralized
mortgages in his hedge fund. Another was Steve
Carell's character Mark Baum, based on
real-life investor Steve Eisman, who (yes) managed
a hedge fund and (yes) shorted investments.

Phrasing the matter that way-which is
how GameStop's current shareholders now view
the issue-makes short sellers sound
depraved indeed. But is profiting from company
failures inherently immoral? The immorality
claim is situational rather than principled. That is,
those who decry profiting from corporate
losses are happy to do so if they believe the
opposition deserves its fate.
For example, some of the short sellers that
GameStop's buyers squeezed were employed by
publicly traded firms. Few mourned the
fate of those companies' shares. More broadly,
many investors for political or religious
reasons dislike certain industries, such as tobacco,
guns, and liquor. They typically do not short
those stocks, but neither do they shed tears over
their stock market woes.

From idols to bums in half a decade! The
transformation is remarkable. It also strikes me
as being entirely wrong.

A popular charge against short sellers is that
they collude to sully the reputations of the
companies that they short by spreading bad news.
Such behavior does occur, and it is unsavory.
On the other hand, abetted by those who own
long positions in their shares, and who
therefore will profit from price appreciation,
CEOs routinely exaggerate their company's
prospects. Is cheerleading by the bulls
more attractive, or better for the economy, than
brickbats from the bears?

To start, Burry and Eisman were not heroes.
They were professionals who saw the chance to
make an investment buck. That was their
job, and not a particularly dangerous or noble
occupation at that. They neither risked nor saved
lives. Admittedly, their trades were financially
hazardous-but so, too, is the launch of any local
restaurant, which places the founder's
capital at risk. If there are films that celebrate the
bravery of those who own diners, I have yet
to watch them.

That, I confess, was a rhetorical question: I think
not. To be sure, if short sellers lie about a
company for personal benefit, they should be held
liable for their words-just as a company's
management commits securities fraud for such
behavior. Also, if short sellers conspire to
reduce a stock's price by making their trades
in unison, they are guilty of market manipulation
and should be treated as such. But otherwise,
I see no harm in investors voicing their opinion.
It's a free country.

What's more, The Big Short's transactions only
profited if homeowners failed. Those investments
would languish unless mortgage defaults
increased. Quite literally, for Burry and Eisman
to be vindicated-that is, for audiences
to cheer the success of the film's protagonists-
residential homeowners needed to suffer.

Not Guilty

In summary, neither The Big Short's portrayal
of short sellers as champions nor WSB's belief that
they harm innocent parties can be justified.
Whether their positions are short or long, investors
are investors. And if short sellers sometimes
exaggerate their target's shortcomings, so as well

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