“If Andre the Giant has his boot on Mike Tyson’s neck, who’s the better boxer?”
With all the chatter about Gamestop (not to mention the cracking memes) I thought I’d weigh in on the subject and flows more broadly.
I’m a fundamental analyst, but there are times when fundamentals don’t matter and flows dominate: fundamentals are Mike Tyson under Andre’s boot.
Gamestop (GME) is the most recent example of flows outweighing fundamentals. The fundamentals of GME are reasonably poor. It’s a brick and mortar retailer serving a market that’s largely online. As a regular murderer of virtual 11-year olds, I can confidently say I’ve never purchased a physical game, I download them.
So why the meteoric run? Mostly investors (and I use the term liberally) buying call options. When an investor is long a call option, the bank providing that contract is short the call option. Given short calls have infinite downside, the bank hedges that risk by going long the underlying stock. The banks do this in a price insensitive manner because they’re not making a fundamental bet, they just want to hedge risk.
In a deep, liquid market this won’t have much of an impact. But when done in size, it can result in enormous moves in stock prices. Essentially, buying enough calls is a self-fulfilling prophecy.
GME is not the first time this has happened: stock gets hyped on internet, and experiences meteoric run. Long ago, in a golden age before Archduke Ferdinand was shot, there was a company called iOmega. It was pumped up by the r/wallstreetbets of the day: Yahoo finance chat rooms. It rose 2,000% in a short space of time as people hyped it online. It subsequently fell 68.1% erasing most of the gains – and for many investors, resulting in losses.
I’ve never made a trade based solely on flows, but I think flows are something fundamental investors should be aware of. I keep flows in mind and realise when fundamentals take a back seat. I’ll use two examples: Tesla and index-tracking ETFs.
I don’t think Tesla (TSLA) is a bad company. I also don’t think it’s ~$800bn of not too bad company. Would I short it? No. Aside from the fact that one should NEVER short on valuation alone, TSLA has a legion of Elon Musk cultists who spend their days debating whether Musk is God or merely Jesus and buying TSLA stock and call options – the flows are going the wrong way. Although I’d suggest these investors read the bible and see that God spends much of his time screwing over his followers, and that Jesus died broke with serious legal issues (which makes the metaphor oddly appropriate), it probably won’t change their minds. TSLA is now in the S&P 500, on which note I’ll move onto indices.
Index tracking ETFs, are another case of flows outweighing fundamentals. When a stock enters an index, the likes of Vanguard, Blackrock and many others deploy billions of dollars in a price insensitive manner buying the new addition. This raises its market cap and therefore its weight in the index, which means further billions must be deployed in purchasing it, in a price insensitive manner.
So how can a fundamental analyst use flows to their advantage? To repeat my earlier point: I won’t enter a position just because the flows look favourable. However, if you have a thesis on stock A and stock B has a similar thesis and prospects but is about to be included in a major index, I’ll go for stock B all day. Conversely, I won’t short stocks, no matter how awful they look, if there are legions of price insensitive buyers in the market. Sometimes, it doesn’t matter who’s the better boxer.
P.S. I'll leave you with perhaps the finest piece of financial analysis I've ever seen