GameStop ‘Squeeze’ Unlikely to Have Lasting Effects on Stock Market, Caltech Economist Says

As the financial bubbles surrounding shorted stocks including GameStop and AMC Entertainment were showing signs of bursting on Tuesday, a Caltech economist said the recent flurry of internet-driven stock trading was not likely to have lingering effects on the stock market as a whole.

After taking notice that hedge funds had shorted GameStop stock by 140%, an avalanche of stock purchases first prompted by reddit.com users sent the share price soaring, Caltech Lecturer in Economics Kenneth Winston explained.

The hedge funds, which had borrowed shares of GameStop in anticipation of the prices going down and repaying the loans with less valued stock down the road, found themselves owing large sums of money to make up the difference, he said.

But the market already appeared to be normalizing as of Tuesday, as stocks, in general, were up, but GameStop stocks, as well as AMC Entertainment stock, which saw a similar trend, were plummeting, the Associated Press reported. Gamestop declined by 47.2% to about $106 per share, while AMC stock dropped by 39.3% to $8.07 per share.  

While billions and billions of dollars are at stake, it’s a small sum compared to the overall stock market, Winston said.

“The size of the U.S. stock market is about $47 trillion and GameStop, at its height, I think was about $16 billion. That’s like one-3,000ths of the U.S. stock market,” he said. With the “air coming out of the balloon” in recent days, the proportion has fallen lower.

“So this really has not a lot of economic consequences. The economics depend on our companies being successful and making products and services that people buy. And that’s the bottom line, always,” Winston said.

“GameStop isn’t going to sell more games because of this. The prospects for their revenues aren’t changed because of this,” he said. “This is a kind of a market technical situation. It’s kind of a spectacular market technical situation, but it’s just a technicality of how markets work. I wouldn’t worry about this transmitting to the overall economy. It really is only affecting hedge fund managers.”

Such situations are nothing new, Winston said, although the recent stir over GameStop was a particularly outstanding example of what can happen with rampant stock shorting.

“140% of the company had been sold short, which is very unusual. AMC is 53% short, so it’s still a lot, but it’s not as extreme as GameStop,” he said.

“It’s important to remember that the fundamentals of the companies are ultimately what matter,” Winston said.

“My takeaway is that there is an imperfection in the markets that allows stocks to get so far away from their fundamentals,” he said. “And I hope that regulators are looking at this imperfection. Again, 140% shorting seems to me like an imperfection.”

Looking forward, “There should maybe be some adjustments in order to make the markets more efficient so that stock prices don’t get so far away from their fundamentals,” according to Winston.

“Most of the time, markets do a good job of reflecting the underlying fundamentals of the company in the price,” he said. “Here, the markets failed to do that. Hopefully, people will give this a lot of thought and think about how to not let the price get so far away from fundamentals.”