Stock Market Bubble Due To Gamestop And Hedge Fund Losses

Is the stock market in a bubble due to Gamestop mania and hedge fund losses? It could very well be as retail investors chase speculative gains in heavily shorted stocks.

From 1999 – 2001, I used to work on the 49th floor of 1 New York Plaza, NYC. The 49th floor was the International Equities sales and trading floor at GS. The atmosphere was electric, just like today.   

However, the mania in the stock market today feels 2X greater than it ever did in 1999 and 2000, during the time of the first dotcom bubble burst. Therefore, I recommend investors be very careful.

I remember buying $3,000 worth of VCSY, a microcap Chinese internet stock in early 2000. I was always hunting for unicorns since college. I told my friends on the Latin America desk who then bought. They told their friends on the US equities desk upstairs and they bought.  

Within a week, everybody I knew in my analyst class had bought VCSY. Then, they told their roommates and friends who worked at MS, ML, and Lehman as well. As a result, VCSY promptly went up 55X within a few short months and then went right back down by the start of 2001.

See the chart below.  

VCSY price action in 99/00 - stock market bubble

Take Some Profits In The Stock Market Bubble Please

I'm confident within six months, most of these names like Gamestop and AMC Entertainment will drop back down to their pre-mania levels.

None of these names are trading on fundamentals. Therefore, if you've been able to benefit from the insanity, I highly recommend you take some profits.  

You can never lose if you lock in a gain. Once you take profits, I suggest converting some money into real assets, hard assets like real estate that will continue to hold value long after these stock bubbles have burst.

From 1999 to 2021, I've consistently used the funny money I've made to buy real estate. Real estate not only provides utility, it also generates income, which is much more valuable today because interest rates have declined so much.

It now takes a lot more capital to generate the same amount of risk-adjusted income. Yet, real estate prices have not reflected this reality yet, hence the opportunity. 

My two favorite real estate crowdfunding platforms to invest in real estate are:

Fundrise: A way for accredited and non-accredited investors to diversify into real estate through private eREITs. Fundrise has been around since 2012 and has consistently generated steady returns, no matter what the stock market is doing.

CrowdStreet: A way for accredited investors to invest in individual real estate opportunities mostly in 18-hour cities. 18-hour cities are secondary cities with lower valuations, higher rental yields, and potentially higher growth due to job growth and demographic trends.

Both platforms are free to sign up and explore. 

I've personally invested $810,000 in real estate crowdfunding across 18 projects to take advantage of lower valuations in the heartland of America.

Taking Aggressive Bets

One of my biggest regrets in 2000 was only buying $3,000 worth of VCSY. My shares peaked at about $165,000 and I sold at about $150,000. If I had the means to buy $30,000 worth, I would have cleared almost $1,500,000 at 24 years old!  

This is obviously greed and fantasy talking since I only had about $5,000 to my name back then. However, today, I have the means. Therefore, I ended up trying to day trade Bed, Bath, & Beyond (BBBY) stock to recreate the magic. I failed. You can read about my adventure here.  

Despite the insanity in some stocks today, I still think it's worth trying to take a punt with a minor portion of your portfolio (1% – 5%). Looking back, all my big wins (and losses) have come from investing in individual stock names.  

The same thing goes for buying real estate. Buying a property is like going all-in on a single stock, usually with leverage (a mortgage). If you hit it right, over a 10-year period, you could become very wealthy. Today, I've decided to go all-in on big city real estate again.  

I'm pretty certain the herd will flock back to big cities once there is herd immunity. I remember San Francisco feeling so desolate when I arrived in 2001. Then things started taking off in 2003. I remember things getting really dire in 2008 – 2010, then things took off again starting in 2011.  

There are only 1-2-year windows of opportunity before prices start running away from us. I will take advantage because my children can't. 

Thoughts On The Overall Stock Market Bubble

Melvin Capital, the hedge fund that was short Gamestop and other names supposedly lost 53% in January according to the Wall Street Journal. Not only is 53% a massive percentage loss, but it's also a massive absolute dollar amount loss given Melvin Capital had over $10 billion in assets under management. 

Melvin Capital has to rebound by 112.7% just to get back to even! If Melvin Capital doesn't get back to even, its fund managers and analysts don't get paid a portion of the profits. In such a scenario, it's easy to see Melvin Capital shut down. It could take years for Melvin Capital to get back to even.

The worry on the street is that Melvin Capital and a bunch of other similar hedge funds will have to liquidate positions in a fire sale and close up shop. As a result, there will be continued selling pressure in the broader markets until enough of these hedge funds close down.  

This has happened in the past. In 1998, when Long Term Capital Management blew up due to too much leverage in wrong-way bets. However, 1999 and part of 2000 turned out to be great years for stocks.  

If you want to read a good book about hedge funds collapsing and roiling the markets, read, When Genius Failed, by Roger Lowenstein.

Buying Stocks In The Sell-Off

We all knew going into this year that equity valuations are rich. Therefore, a sell-off, although disappointing, should not come as a surprise. I've also shared with you my 2021 stock market (and real estate market) prediction, which is decidedly tamer (4,088) than my old shop's prediction of 4,300 on the S&P 500 by year-end. 

Is The Stock Market In A Bubble Due To Gamestop And Hedge Fund Losses?

However, I am a buyer into the sell-off because I still believe the S&P 500 will close up for the year. When there are 2%+ sell-offs, like we saw twice in January 2021, I'm a buyer. If there are more 2%+ sell-offs in the coming weeks, I'm a buyer.

If you do the same, just make sure you review your overall net worth allocation and risk exposure. For me, equities account for ~30% of my net worth.  

There is a lot of liquidity on the sidelines ready to buy. According to The WSJ, even new and existing clients have signed up to invest even more in Melvin Capital on February 1. After all, most people would be a buyer after a 53% loss rather than a seller.  

Further, I've used this latest sell-off as an opportunity to fund my kids' 529 plans for the year. If you haven't fully funded your kid's 529 plans by the gift tax exemption amount ($15,000), contributed to your Roth IRA, traditional IRA, Solo 401k, SEP-IRA, or 401k, I'd contribute something too. 

These investment accounts are for the long-term. Therefore, short-term sell-offs provide opportunity. For example, I won't be tapping my kids' 529 plans for at least another 14 years.

Be Ready To Invest If The Stock Market Bubble Bursts

Just like how we were investing during the March 2020 downturn, be ready to invest again in the next big correction. Fortunes are made during these times. Therefore, make sure you have enough liquidity to take advantage!

If you're interested in getting more free commentary and advice, you can sign up for my weekly newsletter here. I talk about everything from stocks, bonds, real estate, and alternative investments.

About the Author: Sam worked in finance for 13 years. He received his undergraduate degree in Economics from The College of William & Mary and got his MBA from UC Berkeley. In 2012, Sam was able to retire at the age of 34 largely due to his investments that cover his desired lifestyle. He spends time playing tennis, taking care of his family, and writing online to help others achieve financial freedom too. He started Financial Samurai in 2009 and has grown it to be one of the largest independently owned personal finance sites in the world with over 1 million organic visitors a month.

Related: How To Make Lots Of Money During The Next Downturn