Game Over? Stevens Faculty Sound Alarm over GameStop’s Reddit-Driven Rally
Experts Consider the Power Wielded, but Also Challenges Created, by Social Media in Influencing Markets
What’s the course of action for an investor looking at a stock like GameStop?
The retailer’s wild ride on the New York Stock Exchange occupied Wall Street and had amateur day traders boasting about their gains on social media platforms, especially Reddit.
The way Prof. Jonathan Kaufman sees it, this is not an investment strategy so much as it is sitting down to play blackjack at a table crowded with first-timers. You may want to play according to the probabilities, he said, but if those amateurs are playing on hunches, it’s likely to cost other players their money.
“You just want to avoid those situations,” said Dr. Kaufman, a teaching associate professor at the School of Business at Stevens Institute of Technology who runs his own hedge fund. “It's speculating, not investing. Investing is a positive-sum game, and speculating is a zero-sum game.”
At the speed of social media
“Chat-fueled speculation,” as Prof. Kaufman put it, is nothing new. What’s changed is the speed at which the internet broadly, and social media specifically, can drive activity like what’s happening at GameStop.
“It shows the power of something like Reddit to influence markets,” said Dr. Zachary Feinstein, an assistant professor of Financial Engineering. “Paying attention to those less-considered measures, like market sentiment, could be helpful in trying to understand GameStop. There is this goodwill built into the business, and that’s part of its value.”
Prof. Feinstein examines financial contagion and systemic risk in his research, building models to better understand how a crisis spreads through a network. His research on fire sales is the opposite of what’s happening with GameStop, but “there’s a similar feedback loop, or runaway effect, triggered by traditional financiers needing to cut their losses and impacting the price,” he said.
The GameStop story started typically enough, with investors shorting a company they expected to underperform. The involvement of an army of retailer investors is where things went off script — as more and more piled into stock and call options, short sellers got squeezed dramatically.
The ability for companies with strong customer loyalty — like Ben & Jerry’s, or perhaps GameStop — to leverage that goodwill on social media can be a blessing, said Dr. Gaurav Sabnis, an associate professor of Marketing at the School of Business who researches the role these digital platforms have in business.
But that sentiment can cut both ways. Heineken, for instance, came under fire when video of a dogfight made its way onto social media. In the background, Heineken banners are clearly visible, and seem to indicate the brewer sponsored the fight. Heineken proved this was not the case, but the video has proved persistent on social media, where it frequently is shared among users pledging to boycott the brand.
“Heineken now has has a couple of people who are dedicated only to this fake meme — who scan the Internet to look for this popping up online, and who correct the record as it happens,” Prof. Sabnis said. “It’s the kind of action companies have to take in the social media space. The good news is there are tools that can help you with tracking, but constant vigilance is a requirement now.”
A strategic approach to investment
In the classes Prof. Kaufman teaches — including the Stevens Student-Managed Investment Fund, a two-semester undergraduate course in which students devise a portfolio strategy and manage a portion of the Stevens endowment — he advises students on a more quantitative approach to investing.
Students in SMIF don’t short, Prof. Kaufman said, “because the risk is theoretically unlimited.” Instead, SMIF considers factors like probability-weighted cash flows when determining whether a company is a worthy investment target. The kind of noise coming from social media on GameStop would deter the student investors.
“Over time, the performance of the SMIF has gotten better and better as it’s gotten more quantitative and more disciplined,” he said. “We’ve been beating our benchmarks recently with less risk, which you’ll find most hedge funds do not.”
It seems unlikely that casual investors are bringing that sophistication to their positions on GameStop.
“I think there are a lot of inexperienced traders who are getting taken advantage of and probably losing money,” he said. “It may not be at the point where it’s creating any risk to the system, but I don't think it should be left unchecked.”
But checking the problem, Prof. Sabnis said, will be a challenge from a traditional regulatory standpoint.
“It’s basically crowd investing,” he said. “I can’t think of a mechanism to step that. You shut down Reddit, they’ll just move somewhere else.”
Quantitative Finance program M.S. in Financial Engineering School of Business