Cargo Cult Investing

I think what interests me most about the Gamestop story is not the exciting trading action that happened in January. It’s not the drama about retail traders fighting hedge funds. It’s the cult that’s been left behind since it ended.

As a quick recap, Gamestop is an unprofitable video games store. They were losing money back in 2019. Then, the pandemic shut down mall traffic, making things even worse off. Hedge funds tried to profit off the pandemic by short selling Gamestop and other retailers that were unlikely to survive.

Then, the business started doing slightly less badly. Ryan Cohen, founder of Chewy.com, jumped onboard an effort to help the company sell games online. The stock went up a bit, so the hedge funds lost some money.

Some investors on Reddit noticed this and started a movement to buy the stock, to make the hedge funds lose more money. When you buy a stock, the worst that can happen is you lose all the money you invested. When you sell a stock short, your losses are potentially unlimited. If all the retail traders worked together to buy and hold on, the hedge funds would eventually lose so much that they’d be forced to cover their losses. They’d have to buy the stock at a very high price. In a perfect world, every retail trader would sell their shares to the hedge funds at a high price. In reality, well, some people would get out at the top, it would plummet back down, and anyone still holding would lose out.

Reddit made the movement popular with lots of emojis and memes.

Comments told you to hold on tight, with diamond hands: 💎🙌

People assured you that the stock would rocket to the moon: 🚀🚀🚀

The key was not to sell early, because we’re all apes fighting the hedge funds, and apes are stronger together: 🦍🦍🦍

There were warrior memes from Braveheart and 300. “Hold the Line!”

My favorite summary was this emoji heavy explanation of a short squeeze:

All of this worked. The stock price went up over 100 times from it’s low around $4 to its high of $483.

Some hedge funds got run over. I’d estimate that 20 million shares got covered while the price had spiked, for a loss of at least $100 per share. Hedge funds collectively lost 2 billion dollars. That money went to someone, maybe retail traders who sold near the top, maybe other hedge funds in on the action.

Some people got in early and made million dollars payouts. And some people are left holding the bag.

The short squeeze is probably over now — there are only 20 million shares shorted now, down from 70 million. The remaining short sellers are probably in a better position than before. They might have deeper pockets, or they sold short near the peak, so they can’t be pressured as easily.

A lot of retail investors bought in during the peak excitement and lost most of their money as the price sank back down.

There have been a lot of responses to that. Some people sold quickly and took a small loss. Others held out for a week or two and then took a large loss. Some are holding for the long term, hoping the company eventually becomes a successful online business. It might, in the long run, I don’t really know. Lots of online businesses are worth more.

The funny part is that many people are still holding and hoping for a big short squeeze. And they’ve gone right on posting the same memes.

Hold the line! 🦍🦍🦍
Short squeeze incoming! 💎🙌 🚀🚀🚀

WallStreetBets stayed optimistic for about 2 weeks and seems to be slowly giving up. The true believers have moved on to r/GME, where they think the stock is still worth $10,000 per share, when the short squeeze finally arrives.

If you go to one of these forums and tell people the bad news, you’ll get hundreds of downvotes. If you feed them a fantasy that the stock is shooting back up, and they’re going to get rich, you get hundreds of upvotes.

It’s a typical echo chamber effect, most people only want to hear the news they agree with. But, if you kick opposing views out of your forum, eventually you’re left with a cult. The cult developed its own symbols, its own goals, and its own leader:

This all makes me think back to World War 2.

II.

During the second World War, the US and Japan spent several years fighting from one small island to another.

On each island, troops would build airstrips and planes would land. The planes brought all kinds of cargo: clothing, food, medicine, tents, and weapons.

For the Melanesians, this was nothing short of magical. Imagine, you’re a native fisherman. You’ve spent your entire life using a limited set of technology. Then, foreigners show up. A man stands on an airstrip and does some kind of dance. He waves two batons in a certain pattern, he wears a headset:

And then, something comes out of the sky and brings magnificent goods.

A few years later, the war was over. The planes stopped coming, the cargo stopped arriving.

Afterwards, the cargo cults formed. Locals would go out on the airstrip. They’d wave the batons. They’d carve wooden headsets. they’d mimic the movements of the airstrip operators. And the cult leader would promise that the planes would show up and bring more cargo.

Today, well, it looks like:

“Hold the line! 🦍🦍🦍together strong. 💎🙌 🚀🚀🚀”

They keep posting the magical memes. But the stock still won’t go back up. The rocket ships won’t bring the cargo.

III.

I think this is all especially funny because I just went through a similar experience with the MAGA cult.

Trump unexpectedly won in 2016. The polls favoring Hillary were a few percent off. In 2020, Joe Biden was up 8–10% in the polls. Some thought the polls were wrong again this time. And the polls were wrong again, but not by enough. It wasn’t a landslide 10% victory for Biden, it was just a 4.5% victory, with a close win in the electoral college.

For a few hours on election night, it looked like Trump might actually win. He was dominating the in person votes. But, the mail-in votes swung heavily for Biden. By about 4 AM the next morning, enough had been counted that betting markets were leaning strongly towards a Biden victory.

Counting wasn’t really done for another week, but within a day, the market thought it was 90% clear that Biden had won.

And, of course, it wasn’t over then. Trump launched 60+ election fraud lawsuits, of which he won only 1. He promised his supporters they would still prevail, if they had faith and maybe donated to his “stop the steal” fund.

I spent much of November reading election fraud theories, to see if there was any truth to them, and was mostly unconvinced.

And I spent two months betting against Trump supporters. By December, the odds were still up to 15% that Trump would win. I bet thousands of dollars against that, to collect my 15%. And I won.

Trump bettors even thought that Trump had a 10% chance of winning the popular vote, despite being behind by 6 million votes. I bet against that and won.

Some people were so convinced that Trump would prevail that they lost over $100,000 betting on the outcome.

And even today, on one betting site, you can find people betting that Trump has a 5% chance of becoming President by March:

Okay, that’s insane. But, it has all the same elements as the GME cult.

You’ve got your cult leaders (Trump, and also Q).

Instead of being told to “hold the line” while the stock price still goes down, Q tells you to “trust the plan” while your team still loses the election.

Both have a shadowy enemy that they’re fighting. The GME cult thinks they’re fighting evil hedge funds like Melvin and Citadel. The Trump cult thinks they’re fighting the deep state.

Everyone who disagrees is written off. The GME cult believes that any dissenting opinions are written by shills, paid by the hedge funds. The Trump cult thinks that mainstream media is full of corruption and lies.

This echo chamber makes it hard to see the truth. If you like Trump, chances are most of your friends like Trump. It’s hard to imagine that half the voters in this country don’t like him. If someone has different politics, you unfollow them. Everyone you do follow on social media says the election was stolen. You share links to Newsmax. You quit Facebook for Parler. You send donations to Trump’s “stop the steal” fund. You even tried storming the capitol. And yet, the Trump cargo doesn’t arrive, Biden still becomes president.

IV.

I had some guess, back in February, that covid would be bad. My worldview includes pandemics and other outlier events. Most years the flu isn’t that bad, but in 1918, it killed 50 million people. In any given year, there’s a small chance we see another Spanish flu.

If a virus is even 1% fatal, and it infects most of the world, that adds up to a huge body count.

I didn’t really bet on this. I sold some of my investments in February and stocked up on food, thinking the US might do a big lockdown like China did.

I looked to smarter people to see if I was overreacting. To get an idea of how bad the pandemic would be.

In February, before there had been a single US death from covid, Robin Hanson started betting that there would be more than 250,000 deaths in the US.

People were so incredulous that they gave him 10:1 odds.

If there were less than 250k deaths, Robin would have to pay Eric $100. If Robin was right, and covid was deadly, Eric would have to pay him $1,000.

About 10 other people took the same bet.

By fall, Robin Hanson had won.

I checked back in to see if any of the bettors had learned from the experience. Eric wrote a blog post about his loss, where he insisted he was still right. He blamed politicization of covid deaths. He believes that he only lost because the government has mislabelled other deaths as covid deaths to inflate the numbers. He even admits that 378,000 more Americans died in 2020 than in an average year, but he thinks they must have died from something besides the virus, maybe the lockdowns killed them.

I will admit covid didn’t end up being as bad as I expected. The death rate is more like 0.5%, not 2%. As I learned more about the disease, I adapted my behavior. Became less cautious in some ways, more cautious in others.

The rule is the same with markets as with avoiding disease: adapt or die.

V.

I think by now you should have some idea of why markets can be wrong. Some people are stupid and out of touch with reality. If you can find a place to bet against them, there’s free money to be had.

In another sense, the problem with market bubbles is not that people are deluded. The bagholders are. But many of the people buying on the way up are rational actors, chasing a quick profit. Betting into a trend usually pays off, until the very end. Buying GME at $200 isn’t crazy if you’re pretty sure you can sell it to someone else for $300 the next day.

Anyone who is early to the party makes money, as long as they get out in time.

It’s the same with any bubble, whether that’s internet stocks in 1999 or bitcoin in 2017. Everyone who buys in makes money, until things suddenly stop. And then, it’s adapt or die.

Bubbles are a form of social contagion.

In 2017, a few people made money buying Bitcoin. Their friends heard about it, they went out and bought Bitcoin. It got faster and faster until, all of a sudden, it stopped. Maybe some big early investors started selling. Or, maybe there were just no more gamblers left to buy in.

The exact peak price was on December 15th, 2017.

Is there any way to know that the enthusiasm is picking up? Or wearing off?

Look at Google search trends. Here are “bitcoin” searches for the last 5 years:

And, searches for “buy bitcoin” peak about one week before the highest price.

Then, there’s declining search interest, lower trade volume, and lower prices. Time to get out.

The price for Gamestop peaked on January 28th. Searches for Gamestop peaked, on, you guessed it, January 28th:

The price of Dogecoin had a big spike on January 29th and then crashed afterwards. Searches peaked on the same day:

For an even bigger example, consider the Coronavirus market crash we had last March. The market hit it’s lowest point on 3/23/20.

Searched for “coronavirus” peaked on 3/15:

Why the rebound? Well, 3/23 is when the CARES act stimulus got passed. It’s a logical point to start being more optimistic. Unemployment checks started to support people’s income. The fed started supporting markets more.

But, maybe there’s another element here where each investor says: “I just heard about this covid thing, it sounds bad, maybe I’ll sell my stocks and then buy back in after everyone else hears about it.”

Except that, if you’ve waited until late March to sell, literally everyone else had already heard of it, and there’s no one else that’s going to bail out.

Is it possible to make a tradeable system around this?

I’m not sure. Just like with prices, you can only see the biggest search declines in retrospect. Trading meme stocks or dogecoins is a game of greater fools. Maybe it’s easiest to just look around and guess — “am I the last fool to learn about this game, or is there a greater fool I can still sell to, who hasn’t heard about it yet?”

Look around a little more and you might find that this game is being played, over and over and over. Prices are soaring for crypto. For Canadian marijuana companies. For tech stocks with no earnings. For electric car companies with no products.

Notice when the memes are not in your own best interests. With GME stock, it’s 💎🙌. With crypto, it’s HODL (Hold On for Dear Life). For both, the meme tells you to hold to drive up the price. But, when you’re way up, it’s still better to take some profits than risk a total crash.

Remember that hope is not an investment strategy. I’ve learned this the hard way, on several occasions. When you’re down, try to figure out if your investment thesis has changed.

Stop and think when you find yourself in a forum where everyone agrees. If you see every agreeing voice being upvoted and one lone dissenting voice being downvoted, stop and wonder if the dissenter knows something you don’t.

I’m not sure there’s an easy way to spot the peaks. But, hopefully, you can at least recognize when the war is over and stop hoping that the planes are coming back.