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Why the GameStop Affair Is Good for the Stock Market

There’s been a lot of hand-wringing about the havoc last week’s GameStop Affair wrought. I see it in a totally different light.

Stock Sell Chart

There’s been a lot of hand-wringing about the havoc last week’s GameStop Affair wrought. I see it in a totally different light.

After 34 years of providing investment advice to individual investors, nothing surprises me; I’ve internalized the truth of this button.

The GameStop Affair was undoubtedly unexpected.

So when GameStop (GME) stock went to the moon last week I wasn’t surprised. In fact, I was amused to see that the market had evolved one more mechanism for creating a bubble.

As is typical of many bubbles, the buyers who pushed up GME stock were young and extremely risk-tolerant. They were not focused on building healthy retirement accounts. They were trading for quick big profits. And they were not particularly experienced; in fact, many have probably never experienced a down market. This I’ve seen before.

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But what was new about the GameStop Affair was that many of these buyers had found a community through their trading activities, as social media increasingly has filled the gap that restrictions on real-world socializing have created. They can’t go to a bar. They can’t go to sporting events. And they can’t even bet on the many sporting events that have been cancelled in the last 10 months. So they’re betting on stocks, and reveling in the community that stock trading has enabled.

To top it off, the aspect of targeting the fat-cats who run hedge funds added an aspect of vigilante justice to the mix—and further inflamed the spirits of the participants, who at that point had adopted some of the characteristics of a mob.

But then trading was shut down temporarily in the hottest stocks (for rational reasons), the young traders cried foul, and the result of that (this was really unexpected!) was that Senator Ted Cruz and Representative Alexandria Ocasio-Cortez agreed that the government should get involved to fix the problem.

I disagree. I don’t see a problem at all.

The Great Thing About Investing

The great thing about investing is that anyone can do it. All you need is some money. In that way, it’s sort of like driving a boat in most U.S. states. There’s no licensing requirement at all. If you can buy a boat or convince somebody to lend or rent you a boat, you can be captain.

But as professional boaters know, some of those captains-for-a-day can do really stupid things.

The solution to that problem is fairly simple; it starts with education.

And education is the solution to the conditions that created the GameStop Affair, too, and all the other bubbles this crowd will create.

Now, I’m not so clueless that I think these beginners, some of whom have lost a good chunk of money very quickly, will realize that their own actions are the major reason for their losses, and that becoming better educated about investing is part of the remedy. It’s easier to blame others.

But for those that do see the value of education, I have three books to recommend, all focused to some extent on the phenomenon of crowd psychology that was so evident last week and that throughout history has always played a major part in the creation of market tops and bottoms.

First is The Art of Contrary Thinking, by Humphrey Neill, published in 1954, in which we find the classic line, “When everybody thinks alike, everyone is likely to be wrong.”

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Second, from 1896, is Gustave Le Bon’s The Crowd, A Study of the Popular Mind, which includes this: “The masses have never thirsted after truth …Whoever can supply them with illusions is easily their master; whoever attempts to destroy their illusions is always their victim.”

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And third, going way back to 1841, is Charles MacKay’s Extraordinary Popular Delusions and the Madness of Crowds, where we find the quote, “Men, it has been well said, think in herds; it will be seen that they go mad in herds, while they only recover their senses slowly, and one by one.”

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Yes, these books are old, but the main lesson in every one rings as true today as it did when published.

Crowds of People Tend to Behave Irrationally.

And human nature means that is likely to be true for a very long time. Our modern society has made tremendous technological advances, but crowds of people still do very stupid things.

But What About GameStop?

As I write, GME is down roughly 80% from its high of last Thursday. The bubble is deflating. The stock will probably see periods of revival, but the prospects for the year ahead are dim.

In fact, earlier this week I did a poll of the 11 analysts at Cabot, asking them to predict (individually, not as a crowd) where GME would be at the end of June, and at the end of December.

Their average guess for the end of June was 72, (with a median of 50) while their average guess for the end of December was 34 (with a median of 31)—though one analyst predicted that GameStop would be acquired by year-end, at 52.5.

Additionally, one analyst predicted a Phoenix formation, in which the stock will experience a temporary rebirth that will take it to 185 before it collapses again.

If you’re still holding GME, make use of that information as you will. I’m staying away. The Madness of Crowds is not for me.

The Good News

In the meantime, the good news is that we are still in a bull market and there are hundreds of other healthy stocks that are quite worthy of your investment dollars.

The good news is that if our representatives in Washington do enact some legislation that protects individual investors—which is likely given the current Democratic leadership in Washington—it will encourage more new investors to invest in the stock market.

The good news is that after a long period of low levels of individual stock ownership, a new pro-individual investor movement might lead a lot of people to become more educated and intelligent about their investing practices. (I give credit to Robinhood for making investing—or at least trading—attractive to young people, but they did a terrible job educating them.)

You, of course, are different. You’re already learning from Cabot’s experienced staff of analysts, and that fact alone tells me the prospects for your investing account are very good.

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Timothy Lutts is Chairman and Chief Investment Strategist of Cabot Wealth Network, leading a dedicated team of professionals who serve individual investors with high-quality investment advice based on time-tested Cabot systems.