At the start of 2020, the dominant topic on financial markets was the Covid-19 crisis, but early 2021 saw attention shift to what are known as ‘meme shares’. GameStop, the mother of all meme shares, is probably familiar to most investors. To put it bluntly, meme shares are shares for which trading volumes go up not because of the company’s strong performance, but simply because of hype on social media. Among the best known, in addition to GameStop, are companies like AMC and Blackberry. And whereas GameStop has been up by more than 1,000 percent at times since the start of the year, the price of an AMC share has risen by as much as 2,850 percent.
The result is a ‘short squeeze’
Such wild price movements originate with institutional investors such as hedge funds, speculating on falls in a company’s share price by means of short selling. Arrayed against them are a large number of retail investors, who congregate in forums with the aim of frustrating the intentions of the hedge funds. In a concerted action, they invest in a given share and thereby drive up its price, forcing the hedge funds to buy shares to cover their positions. These covers, in turn, push the share price up even higher, creating what is known as a short squeeze. Short squeezes typically occur when more shares are sold short than are actually in circulation. In the case of GameStop, 140% of the shares had been sold short at one point.
Is this scenario possible in Switzerland?
A similar phenomenon is not likely to occur in Switzerland because the necessary conditions and mechanisms are not in place. Switzerland does not have the market structure or the right kind of companies, partly due to the following factors:
- The lack of any trading platforms offering free share trading (e.g. RobinHood) makes it much harder for retail investors to congregate and achieve critical mass
- The rules of the Swiss stock exchange (SIX) prohibit ‘naked shorts’, i.e. short selling without having previously borrowed the underlying security
- Penny stocks are much less common in Switzerland and in Europe generally than in the US
- The exchanges have trading interruptions (such as the ‘Stop Trading Range’ or the ‘Avalanche Stop’) to protect investors from sudden and excessive price movements
- It is more difficult to obtain information about short sales in Switzerland than in the US
This kind of price volatility cannot be ruled out altogether, though. In Switzerland, there are also shares with significant short positions, which would be suitable for a short squeeze. A look over the border shows that this kind of activity already seems to be taking place in Europe. BaFin has warned investors to exercise caution if they are solicited to buy stocks, in the wake of changes in the price of shares in ‘windeln.de’.
Are retail investors manipulating the market?
Although the main aim of many individual investors probably was to bring institutional investors to their knees, the question is whether this kind of behaviour constitutes market manipulation. Looking more closely at the behaviour of retail investors in the case of GameStop, some elements at least could be said to consist of manipulative strategies:
- ‘Pump and dump’– pushing up prices before selling at the peak and letting the price fall
- ‘Rumours’ – the invention and spreading of false or misleading information
- ‘Ramping the market’ – acting in a way intended to boost the market price artificially by creating the impression of high-volume trading
- ‘Cornering the market’ – holding so much of an asset that it is possible to control its price
- ‘Acting in concert’ – informal collusion between several individuals/investors
Short selling by hedge funds is also frequently criticised, however. The fight between David (retail investors) and Goliath (hedge funds) once again brought the subject of large institutional investors’ unfair advantages on the financial markets to the attention of the regulators. The absence of any obligation to disclose short selling could be one such advantage, for example. Regulatory authorities have been discussing this for some time, but so far have not reached a consensus on what should be done about it. Although short selling is often associated with market crashes, empirical research shows that it can also play an important role in a well-functioning and efficient market that provides liquidity and facilitates pricing (see gwp blog post ‘Short selling ban: different rules applied by market surveillance authorities’).
Is the hype over?
Regulators’ objective is to ensure fair and orderly markets. Reactions and regulatory moves are therefore expected from various quarters. Even the exchanges have called for greater regulation in some cases, which is somewhat unusual. And not least, the activity surrounding GameStop shares and other meme shares has also prompted the SEC, the US exchange regulator, to take action. The SEC intends to monitor developments involving meme shares very closely. In addition, a report is expected on the price fluctuations for the GameStop share, which the SEC has announced will be published in summer 2021. In the meantime, however, the craze for meme shares has already entered the second round.