More bubbles, less shorting. What the GameStop craziness could mean for the future of investing

The stock market is known for being unpredictable and volatile, and any sense of normalcy was blown up during the recent GameStop rally.

Most of us know the story by now: After discovering that several hedge funds had bet on the video game retailer losing value, people banded together on the Reddit forum WallStreetBets to drive up its share price by 1,500%. Over the course of January, GameStop’s stock price ballooned to a high of $483 from a low of $17.

The bubble already appears to be popping, with GameStop shares down to around $55 as of Friday.

Still, the event is unlikely to be soon forgotten, experts say.

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The Reddit forum of retail investors vowing to take on Wall Street still has more than 8.5 million subscribers (or as they call themselves, “degenerates”). And Netflix is already in talks to make a film dramatizing the battle royale between giant hedge funds and a pack of individual day traders.

What’s more, experts say the event tells us about what’s bringing people into the market these days — and what that could mean for investing in the future.

In many ways, the GameStop rally resembles bubbles of the past, but it has some unique characteristics, too, experts say.

“What is new is the scale and speed of the event,” said Veljko Fotak, associate professor of finance at the University at Buffalo.

The ubiquity of smartphones on which people can download investing apps, the availability of cheap or free trading and “a pandemic with a lot of restless energy,” are all factors that contributed to the video game retailer’s rally, said Dan Egan, vice president of finance and investing at Betterment.

Populism spreading across the globe is yet another factor that fueled the bubble, Fotak said. “Some investors were motivated not just by pure greed, but also by a desire to ‘stick it to the man,'” he said.

Many people are also brought into the market these days when they see friends or people they follow on social media touting certain stocks, said David Sekera, chief U.S. market strategist at Morningstar. Some of these posts are very convincing: Users on Reddit, for example, were exchanging high-level analysis on GameStop’s finances.

“The days that equity research was limited to the large, bulge bracket Wall Street firms is long past,” Sekera said.

All of these events that propelled the GameStop bubble could spur many more.

“I do think that, to some degree, this herd Reddit movement is going to continue,” said Jason Reed, a finance professor at the University of Notre Dame. “We’ve already begun to see the movement into other equities and assets, like AMC, Blackberry and silver gaining considerable momentum.”

More people investing is positive, but only if they’re doing so wisely, experts say.

Those who buy stocks based off posts on social media, for example, are often taking risks with money they can’t afford to lose, Egan said.

“One of the biggest concerns is newer investors seeing a ‘hot’ stock, but not fully understanding the ramifications of investing in it,” he said. “A lot of retail investors could lose their shirt.”

Fotak said he read of one recent law school graduate who said he was elated by his wins on GameStop.

“He could now afford to pay off his student loans,” Fotak said. “Yes, there is a lot of greed at play here.

“But there is also a lot of desperation,” he added. “I really, truly, hope he sold right away.”

Hedge funds that had shorted GameStop suffered huge losses as the pack of day traders on Reddit bought the stock en masse, shooting up its price. Melvin Capital, for example, lost more than 50% in January.

Those setbacks could make other investors more skittish about shorting, or betting against stocks, experts say.

“After seeing several other funds get carried off the field on stretchers from these short positions, hedge fund managers will be much more cautious as to which stocks they will be willing to short,” Sekera said.

Less shorting means a less healthy market, Fotak said.

Bubbles tend to be less common in countries where short sellers are less restricted, he said. That’s because short sellers’ pessimism can balance out some of the optimism about a certain sector or stock.

“And in this climate, with market valuations at record levels, we need the contrarian views of short sellers more than ever,” Fotak added.

Another advantage of short sellers is that they often expose serious problems at companies that other investors and regulators have missed, Fotak said.

“Since they are looking for firms that are overvalued, they are always on the lookout for fraud,” he said, adding they often publish research on companies’ bad practices.

And so it’s unfortunate that the GameStop debacle may curb shorting, Fotak said.

“To the extent that delays the release of negative information, we all suffer from a less efficient market,” he said.