As per Wikipedia, GameStop Corp. is an American video game, consumer electronics, and gaming merchandise retailer.[2] The company is headquartered in Grapevine (a suburb of Dallas), Texas, United States, and is the world's largest video game retailer, operating 5,509 retail stores throughout the United States, Canada, Australia, New Zealand, and Europe as of February 1, 2020.
The company was first founded in Dallas, Texas in 1984 as Babbage's, and took on its current name in 1999. The company's retail stores primarily operate under the GameStop, EB Games, ThinkGeek, and Micromania-Zing brands. The company declined during the mid-late 2010s due to the shift of video game sales to online storefronts and failed investments by GameStop in smartphone retail.
It isn't the amazing short squeeze gains in GameStop that are a problem; it's what the trading reveals about the weakness at a brokerage like Robinhood.
Is there a connection between the runaway rally in GameStop and the drop in the market as a whole?
Yes, but it's not the one that might first come to mind. The jump in GameStop, as extreme as the valuation may now be (and as wrong as many believe it to be) is not a threat to the market as a whole. GameStop is another indicator that this market is at or near a top and that valuations
are too "generous" but what else is new. This market has been in this territory for a while.
No, instead it's what caused the trading halt in GameStop by RobinHood and other no-commission, on-line only brokerage apps that has spooked the market. The worry is that the trading halt revealed a systemic weakness in part of the market and some brokerage companies that could indicate more widespread problems and that could catch-up other financial firms.
You see–despite the rhetoric from Robinhood and competitors–this trading
halt had nothing to do with "protecting" individual investors or damping a
speculative blow-off.
All the evidence is that Robinhood was in danger of running out of money.
According to the New York Times, Robinhood drew on a line of credit from
six banks amounting to between $500 million to $600 million to meet higher
margin requirements from its central clearing facility, the Depository
Trust & Clearing Corporation, created by the huge volume of trades in
GameStop and similar "rally" stocks. And then Robinhood raised $1 billion
from existing investors such as venture capital firms Sequoia Capital and
Ribbit Capital to provide the capital it needed to meet the cash demands
from all the trading. (Brokerage companies need cash to pay customers who
owed money from trades and have to post additional margin cash to that
central clearing facility to insulate trading partners from potential
losses if Robinhood couldn't come up with the cash when it came time to
settle a trade.)
In other words, Robinhood, one of the largest online trading apps, didn't
have the capital to meet the cash demands created by the huge volume of
trades its customers were making. And it had to limit trades to gain time
to raise the cash it needed.
Now, Robinhood running low on cash to meet its obligations to customers and
to trading partners isn't the same thing as, say Goldman Sachs running low
on cash and having to halt trading. That would send financial markets into
a nosedive of major proportions. But Robinhood is a major player in the new
world of FinTech and financial online apps. It's not clear to anyone that
these new companies are sufficiently regulated or that the Federal Reserve
is holding them to tight enough standards.
So, yes, the GameStock "event" has been enough to move some worries from
nagging back of mind niggles to closer to front of mind concern. Remember
that in the last two decades we've had plenty of financial "corrections"
start in relatively obscure corners of the market–Long Term Capital and the
subprime mortgage disaster are two examples that come to mind.
In a market priced to perfection and that's counting on a big recovery in
earnings (and no disruptions) the trading halt at Robinhood is a disconcerting reminder that it's the things that you aren't watching that
can go wrong and bite you.
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