The GameStop Meme Stock Craze Hits the Cinema

The lesson of ‘Dumb Money’ is that a wise crowd can easily turn into a stupid, dangerous mob

By Clifford S. Asness. Excerpts:

"The film is being hailed as a David-vs.-Goliath story, the little guy’s triumph over the Wall Street elite. That’s true only if you define triumph as a mob gleefully taking down one hedge-fund manager—Melvin Capital’s Gabe Plotkin—for short-selling the videogame company’s stock. Never mind that his demise came as thousands of people who gullibly bought during the “moonshot” phase of GameStop’s dramatic rise almost certainly lost money in the aggregate."

"the crowd of “little guys” was misled by deceptive or incompetent social-media hucksters into buying something that was very obviously overvalued"

"Third, too often we discard or warp time-honored principles to bad ends. Here I’m thinking of “HODL”—or “hold on for dear life”—the online crowd’s exhortation during the GameStop fiasco. I am a lifelong advocate of sticking with a good long-term strategy even through rare but excruciatingly tough times, so this one strikes me as nearly correct but wrong for a key reason. You see, I sneaked a word in there—“good.” Sticking with something through thick and thin works only if that thing is worth sticking to. You can’t apply it to anything, including the most obviously overvalued junk in the world, and win simply because you’ll never sell. That’s a recipe for asymptotically approaching a zero-brokerage balance.

Fourth, if you’re trading your 401(k) based on your hatred of and desire to harm a certain class of people, you’re probably letting your bias hurt your bottom line. The same dynamic applies outside the investing world.

Fifth, we often correctly marvel at the “wisdom of crowds,” but this phenomenon is based on the crowd’s members being reasonably independent of one another. Think about how effective polling the audience is on “Who Wants to Be a Millionaire?” It works only because members of the crowd don’t talk among themselves. If they were to launch into fiery speeches weighing the multiple-choice answers, you’d likely get a much different and worse result.

Crowds of independent thinkers are often very wise, even if each individual isn’t. Crowds that share information and come to a shared conclusion are often—though not always—dangerous mobs. In the meme-stock craze, as in our politics and elsewhere, the internet seems to be a perfectly designed vehicle for turning a crowd of independent thinkers into an angry mob.

GameStop’s ugly episode showed that aggrieved and ill-informed—or even sadder, desperate—“investors” can take down a single smart one. Fascinating. But we knew this before. A long-term market maxim is that “the market can stay irrational longer than you can stay solvent.” Perhaps a necessary rejoinder is that even so, the rational usually win and the irrational usually lose. Moreover, when the rational lose, the irrational often end up losing too.

We also saw that Hollywood will happily take a situation it doesn’t understand and make a movie about it, replete with cartoon heroes and villains, which only lowers our discourse and intentionally makes us hate and distrust each other even more. Oh, and the same industry will do so for money while excoriating greed. But then again, we already knew that too.

Mr. Asness is managing and founding principal of AQR Capital Management."