Radnor News / Blog


Tue
3/2/21

posted by: Radnor Financial Advisors

Trading Games or Gaming Trades? Revisiting Market Efficiency in Light of the GameStop Short Squeeze

While this year’s Super Bowl may not have been the most thrilling one of our generation, it certainly had many paying close attention.

A record 7.6 million people bet on this year’s Super Bowl with online sportsbooks, up 63 percent year-over-year. The
ease of opening a smartphone application, linking a bank account, and placing wagers within a matter of minutes has
driven more and more people into this market each year.

Of course, Super Bowl bettors were not the only ones busy transacting on their smartphones in January. The well
documented short squeezes of Gamestop (GME) and several other stocks have taken center-stage in the investment
community for over a month. The ability of non-institutional investors to manipulate certain securities for an extended period of time may have undermined public confidence in the reliability and fundamental soundness of stock pricing. You might be wondering: Is today’s price of an S&P 500 index fund an accurate indicator of economic value? Or is it more like a wager- benefiting those who can identify mispricings at the expense of those who cannot?

Numerous books and scholarly articles have been published over the years to address whether or not markets are
“efficient”, or that assets traded in public markets such as the New York Stock Exchange are doing so at prices reflective of an accurate interpretation of all publicly available information. Most have found markets to be highly, but not perfectly-efficient. The practical implications of these findings are that the price you pay today for a share of stock is a very good estimate of the present value of all future cash flows it is expected to ever yield, and that the return it generates over time will primarily be a function of the level of risk associated with that expectation. In other words- it is a fairly reliable economic indicator.

With that being said, there are certainly inefficiencies that show up in markets all the time that appear to have little
fundamental basis. Just last year, the S&P fell by almost 34% over the course of a few weeks in the spring before we
knew much at all about COVID-19. Even at the time it felt more like the result of very understandable panic than
calculated financial analysis. This year, we have seen social media take control of securities to sabotage several hedge
funds and profit at their expense. Clearly market prices do not always move in lockstep with precise economic values
which certainly can create an added layer of volatility for investors.

Nevertheless, the existence of temporary, moderate inefficiencies would not significantly diminish long-term positive
returns in a primarily efficient market. While the Reddit participants may have been successful in manipulating
GameStop- a low-priced, lightly-traded stock with heavy short interest- for a period of time, they could never have done so to the broader financial markets.

Thus, unlike a wager, long-term stock market investing is not a zero-sum game; you do not need to rely exclusively on outsmarting others to make it profitable. While the market may not be correct all of the time, the fact that it is very efficient over time should give investors confidence in the reliability of an appropriately diversified portfolio.

Important Disclosure Information

Philip I. Fried

Financial Planner

View Bio

×
×