Out-Memeing the Market

I shall forgo the cheap thrills of writing about forced monkey labor or Chinese anal swabbing and instead start with something that unites rather than divides. At least I hope that, in the year 2021, one thing that everyone—not virtually everyone, or almost everyone, but literally everyone—can agree on is that people do dumb things.

Now there’s ample disagreement about what constitutes dumbness. If I see a dude say, “Hold my beer while I pose with these wild tiger cubs. I’m sure the mom won’t mind,” I think “Moron,” but someone else might see brilliance. (Or, at least, a free beer.) Still, I think we can all agree that people do stupid stuff.

I’m using “stupid” broadly to mean everything from swallowing Tide Pods to merely doing or saying stuff we disagree with.

Which brings me to this GameStop thing. Now, I don’t write about the stock market, at least not in any technical or professional detail, because I really only understand the basics. If you want to read an explainer that—again, conceding my own limited grasp of such things—strikes me as very good, I recommend this piece by James Surowiecki, author of one of my favorite books, The Wisdom of Crowds.

GameStop is like the Blockbuster of video games, i.e., you go to the store and buy the physical game and bring it home—and it’s not a great company. It hasn’t made a profit in two years. Because it’s not a great company, it’s heavily shorted, which just means that lots of investors (or a few big investors) are betting the stock price will go down.

Well, a bunch of folks at Reddit have apparently figured out that, for fun and/or profit, they can punch the shorters in the shorts by bidding up the price of the stock. On Monday morning, shares rose about 160 percent over a few hours. GameStop is merely the most famous of a whole category of such cases called “meme stocks.” Movie-theater chain AMC is another one seeing a huge spike in share price.

Over the last couple days, I’ve seen a whole bunch of people on Twitter claiming that the GameStop gambit proves that the Efficient Market Hypothesis (EMH) or libertarian faith in markets should somehow be shattered.

According to Investopedia, “The efficient market hypothesis (EMH), alternatively known as the efficient market theory, is a hypothesis that states that share prices reflect all information and consistent alpha generation is impossible.” It goes on:

According to the EMH, stocks always trade at their fair value on exchanges, making it impossible for investors to purchase undervalued stocks or sell stocks for inflated prices. Therefore, it should be impossible to outperform the overall market through expert stock selection or market timing, and the only way an investor can obtain higher returns is by purchasing riskier investments.

If you take this description literally, I guess the dunkers have a point. But this strikes me as strawman-ish. For starters, EMH is a model, hypothesis, or theory, not a law. In the real world some actors have access to more, better, or timelier information than others. In the real world, some people will be better at interpreting widely available information and acting on it wisely and quickly than others. And, in the real world, some people are just lucky. Of course, in a big enough market, these advantages often wash out quickly. Coattail investors see what the smart money is doing and follow suit. In other words, if you’re a relatively passive buy-and-hold investor, betting that the EMH is more right than wrong is probably the safest way to go. But, if you’re Warren Buffett, then by all means try to outthink the market—you’re good at it.

There is no Homo economicus.
Let me briefly retreat to ground from which I can write with a bit more confidence. This whole debate reminds me a little of the phrase Homo economicus, or “Economic Man.”

As I note in Suicide of the West (now out in paperback!), the phrase emerged as a criticism of John Stuart Mill and other thinkers who allegedly reduced human beings to purely economic animals. But the thing is, outside of some weird Randian and Marxist backwaters, no one really argues that this is the sole or even best way to understand human beings. To put it starkly, suicide bombers are not acting purely on their rational economic self-interests, and yet I’ve never met a “market fundamentalist” who denies that suicide bombers exist. In other words, Homo economicus is one of those terms, like “social Darwinism,” that has few (if any) adherents, but is especially useful as an intellectual epithet. Mill himself made it clear that his definition of man as a profit-maximizer was bound to the study of economics:

Geometry presupposes an arbitrary definition of a line, “that which has length but not breadth.” Just in the same manner does Political Economy presuppose an arbitrary definition of man, as a being who invariably does that by which he may obtain the greatest amount of necessaries, conveniences, and luxuries, with the smallest quantity of labour and physical self-denial with which they can be obtained in the existing state of knowledge.

An expert on basketball would have a definition of Homo basketballis that would largely ignore what the players did off the court. Is it any scandal that an economist would have a definition of people that was contingent on economic activity? I think behavioral economists—often pitted against classical economists—have made many important contributions, but that doesn’t mean that traditional economics has no value.

Not perfect, just better.
If you look at EMH as a rule of thumb or truism—or, more broadly, if you see markets as moreefficient compared to the alternatives—there’s really no arguing with it. Markets are better—i.e. more efficient and productive—at distributing resources than any other method of economic organization. It’s fine to scream “You’re not perfect!” at a strawman every time markets yield (allegedly) suboptimal or irrational results. But until they actually come up with an AI supercomputer that can outperform the market in delivering gluten-free quinoa to Ontario, uranium to Tokyo, and mint condition Rock ‘Em Sock ‘Em Robots still in the box to David French, all on the same day at affordable prices, the market is the best option.

For some people, EMH, like Homo economicus, is a stand-in for the claim that markets are perfect. Let me, as a very pro-market guy, concede that they are not perfect. For starters, as mentioned above, people do dumb things. The Tulip Craze story of 1630s Holland may have been exaggerated, all the better to take shots at markets, but it’s certainly true that tulip prices went kind of crazy given that tulips are, well, frickin tulips. When I was kid, sticker mania overtook my school. Kids were spending every spare penny they could find to buy useless stickers, particularly puffy ones. Some kids, like my brother, were perfectly happy to profit off this irrational bubble (he had a good sticker connection).

People spend money on stupid things. But the heart wants what the heart wants, and if enough hearts are involved, there you will find a market. If the market is robust enough, then smart people will get into the business of selling you stupid things. The more people who enter the market, the more efficient it will get.  

One other point about markets: While they are very fast at taking in new information—hence that efficiency thing—their efficiency can only really be seen or revealed over time. Tickets for the Titanic (the ship, not the movie) were a hot commodity when it was in the dock. Their value plummeted a few days later. When Donald Trump floated the idea that hydroxychloroquine was a miracle treatment for COVID, there was a run on hydroxychloroquine that created shortages. If you took a snapshot of black market hydroxychloroquine prices at the time, I’m sure it would look a lot like the current share price of GameStop.

Now, do you think the ascent of that line would be more or less stark if we lived in a non-market economy?

As for the meme stock traders, it’s worth noting that while some are apparently making money at it—early investors in Ponzi schemes can also make money—it also appears that many of them aren’t looking for financial profits so much as psychic ones. They think they’re sticking it to the man. In some ways it’s the financial market equivalent of QAnon and other shitposters who may not know whether pedophile vampires actually run the Department of Housing and Urban Development, but who are certain that they enjoy the freakouts that result.

I have no idea how to fix that problem or whether any attempt to fix it would be worse than the problem itself. But my suspicion is that, eventually, the market will figure out how to deal with people stupidly purchasing stocks in companies that aren’t worth the investment on the merits. Markets have a way of efficiently punishing that sort of thing—over time.