Morning Comment: The REAL Reason Why GameStop's Action Should be a Concern

Everybody has been talking about GameStop (GME) in recent days...which makes total sense given that the stock had rallied over 3,000% from its August level...and it has done this even though its prospects are worse than anything Judge Smells would ever describe. (They sssssssssssuck!) This has led some people to say that the recent action in GME is another sign that the broad market has become a speculative bubble. They say that the willingness to buy this stock at these crazy levels is another sign of froth.

Well, the recent action in GME is certainly a reason for concern, but most of those people who are talking about GME are not discussing the REAL problem with its recent action. Most of people who are talking about this issue are not taking the next going into the details of what has taken place in GME in the last week or so. In other words, even though most people realize that this situation with GME has little to do with traders “willingness” to buy the stock at these stratospheric levels...and much more to do with them getting squeezed (in the mother of all short squeezes)...they don’t discuss what it really means for the rest of the market. They don’t discuss how the term “short squeeze” is just another way of describing “forced buying”...and that it works in the opposite direction when “margin calls” create “forced selling”!!!

Therefore, the real issue surrounding the irrational rally in GME is that is shows what can happen when to many people get on one side of the boat...especially when they get to that one side of the boat with large levels of leverage. (Since short sellers are by definition leveraged...and the short interest on GME was very, very high...the situation became a dangerous one for the short sellers.)

The thing is, in today’s stock market, we also have A LOT of leverage (much more leverage) on the long side of the can be seen in the record high levels of margin debt. Therefore, at some point, there is a very good chance that we’ll see a lot of “margin calls” when the inevitable correction takes place in the stock market. (In the same way that “short squeezes” are an example of “forced buying”....“margin calls” are an example of “forced selling.”) Therefore, in the same way that “forced buying” clobbered the investors who had leveraged short positions in GME, “forced selling” will clobber those investors who now have many highly leveraged long positions...when the eventually (and inevitable) correction in the broad market takes place.

The problem is that the huge level of leverage on the long side of things is not just situated in a small number of it is on the leveraged short side of things today (GME, BBBY or PLTR). It is in a large part of the stock market (and other risk assets). Thus, when we get that inevitable correction, the “forced selling” that will ensue in the broad stock market will push it lower than it would normally fall. With this in mind, the perma-bulls who say, “We can ALWAY get a 10% correction”...but it won’t be worse than that” are just plain wrong. Sure we CAN get a mild 3%-5% correction, but when it becomes a 10% (give or take), the “forced selling” (margin calls) that will result...insures that a 10% drop will become something deeper than “just” a normal/mild correction. In other words, the next 10% correction will not be able to stop at that will keep “forced selling” will make the situation worse.

No, we are NOT saying that the huge short squeeze (“forced buying”) in GameStop over the past several trading days means that we will get a significant period of “forced selling” immediately. As we all know, high levels of margin debt are not a good timing we’re not saying that investors should expect to see the broad market roll-over in the next week or two. (It COULD happen...we’re just saying that the action in GME tells us nothing about the TIMING of the next down-turn in the stock market.) However we ARE saying that what has taken place in GME recently will also happen to the broad market (in the other direction) eventually. It might not happen for a long time, but it WILL take place. Extreme levels of leverage are never worked-off gradually...not ever.

Fear & greed are deeply imbedded traits of human beings, so they won’t suddenly start lowering their levels of leverage while the market is rising. They’ll only add to that leverage. More importantly, they will only take it off when they are “forced” too...when the market’s trend has reversed.

“Forced selling” is just like “forced buying”...and they both create some ridiculous moves in the market place. This is what has taken place for centuries (and for millenniums for that matter). It wasn’t different for GME & BBBY...and it won’t be any different for the broad stock market at some point in the coming weeks or months.

Having said all this, any outsized decline in the stock market is something that will provide a great buying opportunity for investors. However, it will ONLY provide a great opportunity for those who are not leveraged...and those who have some cash on the sidelines to invest when this upcoming (inevitable) bout of “forced selling” does indeed take place.

Matthew J. Maley

Managing Director

Chief Market Strategist

Miller Tabak + Co., LLC

Founder, The Maley Report

275 Grove St. Suite 2-400

Newton, MA 02466


Although the information contained in this report (not including disclosures contained herein) has been obtained from sources we believe to be reliable, the accuracy and completeness of such information and the opinions expressed herein cannot be guaranteed. This report is for informational purposes only and under no circumstances is it to be construed as an offer to sell, or a solicitation to buy, any security. Any recommendation contained in this report may not be appropriate for all investors. Trading options is not suitable for all investors and may involve risk of loss. Additional information is available upon request or by contacting us at Miller Tabak + Co., LLC, 200 Park Ave. Suite 1700, New York, NY 10166.

Posted to The Maley Report on Jan 26, 2021 — 8:01 AM
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