The Crazy World of Stonks Explained
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You may have seen diamond hands, rockets, and r/wallstreetbets rallying cries in the past few weeks—but what does it all mean? In this graphic we explain the events that led to an explosive rise in GameStop’s share price, along with the Reddit revolution fueling it.
Gamestop’s stock has been on a wild roller coaster ride, rising by roughly 640% from the start of last week to its peak. After Robinhood and other brokers initializing trading restrictions due to the heightened market activity, the stock has since fallen more than 80% to $90 per share.
But the stock’s volatile price action doesn’t come close to telling the story of how this market frenzy began on the Reddit community r/wallstreetbets, the hedge funds that suffered when GameStop share price rose dramatically, and why Robinhood halted trading last week.
The Beginning of the GameStop Saga
While GameStop’s share price went higher than anyone expected this past week, the initial idea behind this rally was shared back in September 2019 by u/DeepFuckingValue, a frequent user in the r/wallstreetbets subreddit, a community where trade and investment ideas are shared.
The premise of his trade idea was simple: he saw unrecognized value and much more upside potential compared to the downside risk in GameStop.
While people were eager to proclaim the death of physical game sales, u/DeepFuckingValue noted the new generation of consoles on the horizon would bring gamers back to GameStop. Along with the company’s new board of directors and solid balance sheet, GameStop wasn’t as poorly positioned as many thought.
Among those betting against the company were a variety of hedge funds and other players who had an outstanding short interest against the stock. Just like the legendary investor Michael Burry proposed after him, u/DeepFuckingValue noted the possibility of a short squeeze if GameStop’s share price moved higher.
GameStop Rockets to the Moon
A collection of shorts had amassed on the game retailer’s stock, with hedge funds like Melvin Capital Management holding onto shorts for multiple years despite GME being at all-time lows. The r/wallstreetbets community caught onto this high short interest and wanted to “squeeze” them out of their positions.
In August and September of 2020, GameStop broke up from its lows around $4 a share, and returned 66% and 53% respectively, reaching new highs of $11 a share. Hedge funds piled in further as short interest on publicly traded shares reached 120%, yet GameStop’s uptrend continued, reaching more than $20 a share by the end of December.
Here’s what’s happened since:
|Date||GameStop (GME) Share Price||DeepFuckingValue's Unrealized Profits|
Sources: TradingView, /u/DeepFuckingValue’s Reddit posts
As GameStop’s price ran into the triple digits by the end of January, Melvin Capital was forced to close their short position despite a $2.75B investment from Citadel and Point72. At the same time, in just a few weeks, the number of r/wallstreetbets subscribers shot up from 1.8M to 8.3M.
Robinhood Halts Trading and Institutes Position Limits
On January 28th, when GameStop shares reached highs above $460, Robinhood and other brokers halted purchases of GameStop shares and options along with the ability to purchase fractional shares of securities. The broker had received a bill from the NSCC (National Securities Clearing Corporation) of $3B, reflective of the high volatility and value at risk on the platform.
In an informal interview with Elon Musk on Clubhouse, Robinhood CEO Vlad Tenev said that halting purchases and instituting position limits allowed the bill’s cost to ultimately drop to $700M. Before this interview, the company published a blog post of what happened on their end, along with an explainer of how trades are settled with clearinghouses.
While position limits which limited the amount of shares and options users could buy had originally been placed on 51 different securities, today only five have position limits. These include r/wallstreetbets favorites like GameStop (GME), AMC Entertainment (AMC), and Nokia (NOK).
Robinhood’s New Position Limits
You can see the latest position limits on Robinhood’s platform here.
Along with these position limits, Robinhood has instated further limitations related to pattern day traders. This limits users with less than $25,000 in their account to fewer than four trades over five business days.
r/wallstreetbets Discovers Dogecoin and Eyes Silver Shorts
As buying was halted for many of the preferred r/wallstreetbets stocks, the community shifted its attention to the cryptocurrency Dogecoin. Prior to the 28th, Dogecoin had been trading for $0.007 a coin, but in less than 24 hours the coin rose 1,000% to a high of $0.086.
Following this, the meme-based cryptocurrency has since levelled off around $0.033, which is still nearly a 350% return for anyone who had bought before the 28th.
Since their foray into cryptocurrency, some r/wallstreetbets users have now identified silver as a new opportunity with short squeeze potential. Since the 28th, silver has risen about 5%. Increased volumes for various silver brokers caused delays or resulted in the suspension of silver purchases over the weekend.
Despite the rally and growing excitement around the precious metal, there are those in the r/wallstreetbets community who consider this a distraction. Malicious players with a short interest in GameStop may be trying to draw attention away from the GameStop short squeeze.
What’s Next for Robinhood and r/wallstreetbets?
Since these unprecedented market events, Robinhood raised $3.4B in an investment round to further support their goal of “expanding everyday investors’ ability to invest”. Yet the company faces dozens of lawsuits for their halting of share purchases on the 28th of January, and will likely have to put its IPO on the backburner.
Their decision to halt purchases ultimately removed large amounts of buy pressure from GameStop and other securities, and its newly instated position limits and pattern day trader rule have driven many users away from the platform.
With their actions, Robinhood unwittingly spurred a deep divide between Main Street and Wall Street. Many r/wallstreetbets members now feel their trades and investments carry an idealistic importance worth more than potential profits or losses.
While there is still plenty of this story left to play out, last week saw an irreversible change in how many individual investors perceive the market, its participants, and its rules. While new rules and regulations will change shape going forward, one thing is clear: the rise of information sharing has changed how financial markets will be traded forever.
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Interest Rate Hikes vs. Inflation Rate, by Country
Inflation rates are reaching multi-decade highs in some countries. How aggressive have central banks been with interest rate hikes?
Interest Rate Hikes vs. Inflation Rate, by Country
Imagine today’s high inflation like a car speeding down a hill. In order to slow it down, you need to hit the brakes. In this case, the “brakes” are interest rate hikes intended to slow spending. However, some central banks are hitting the brakes faster than others.
This graphic uses data from central banks and government websites to show how policy interest rates and inflation rates have changed since the start of the year. It was inspired by a chart created by Macrobond.
How Do Interest Rate Hikes Combat Inflation?
To understand how interest rates influence inflation, we need to understand how inflation works. Inflation is the result of too much money chasing too few goods. Over the last several months, this has occurred amid a surge in demand and supply chain disruptions worsened by Russia’s invasion of Ukraine.
In an effort to combat inflation, central banks will raise their policy rate. This is the rate they charge commercial banks for loans or pay commercial banks for deposits. Commercial banks pass on a portion of these higher rates to their customers, which reduces the purchasing power of businesses and consumers. For example, it becomes more expensive to borrow money for a house or car.
Ultimately, interest rate hikes act to slow spending and encourage saving. This motivates companies to increase prices at a slower rate, or lower prices, to stimulate demand.
Rising Interest Rates and Inflation
With inflation rates hitting multi-decade highs in some countries, many central banks have announced interest rate hikes. Below, we show how the inflation rate and policy interest rate have changed for select countries and regions since January 2022. The jurisdictions are ordered from highest to lowest current inflation rate.
|Jurisdiction||Jan 2022 Inflation||May 2022 Inflation||Jan 2022 Policy Rate||Jun 2022 Policy Rate|
The Euro area has 3 policy rates; the data above represents the main refinancing operations rate. Inflation data is as of May 2022 except for New Zealand and Australia, where the latest quarterly data is as of March 2022.
The U.S. Federal Reserve has been the most aggressive with its interest rate hikes. It has raised its policy rate by 1.5% since January, with half of that increase occurring at the June 2022 meeting. Jerome Powell, the Federal Reserve chair, said the committee would like to “do a little more front-end loading” to bring policy rates to normal levels. The action comes as the U.S. faces its highest inflation rate in 40 years.
On the other hand, the European Union is experiencing inflation of 8.1% but has not yet raised its policy rate. The European Central Bank has, however, provided clear forward guidance. It intends to raise rates by 0.25% in July, by a possibly larger increment in September, and with gradual but sustained increases thereafter. Clear forward guidance is intended to help people make spending and investment decisions, and avoid surprises that could disrupt markets.
Pacing Interest Rate Hikes
Raising interest rates is a fine balancing act. If central banks raise rates too quickly, it’s like slamming the brakes on that car speeding downhill: the economy could come to a standstill. This occurred in the U.S. in the 1980’s when the Federal Reserve, led by Chair Paul Volcker, raised the policy rate to 20%. The economy went into a recession, though the aggressive monetary policy did eventually tame double digit inflation.
However, if rates are raised too slowly, inflation could gather enough momentum that it becomes difficult to stop. The longer high price increases linger, the more future inflation expectations build. This can result in people buying more in anticipation of prices rising further, perpetuating high demand.
“There’s always a risk of going too far or not going far enough, and it’s going to be a very difficult judgment to make.” — Jerome Powell, U.S. Federal Reserve Chair
It’s worth noting that while central banks can influence demand through policy rates, this is only one side of the equation. Inflation is also being caused by supply chain issues, a problem that is more or less outside of the control of central banks.
3 Insights From the FED’s Latest Economic Snapshot
Stay up to date on the U.S. economy with this infographic summarizing the most recent Federal Reserve data released.
3 Insights From the Latest U.S. Economic Data
Each month, the Federal Reserve Bank of New York publishes monthly economic snapshots.
To make this report accessible to a wider audience, we’ve identified the three most important takeaways from the report and compiled them into one infographic.
1. Growth figures in Q2 will make or break a recession
Generally speaking, a recession begins when an economy exhibits two consecutive quarters of negative GDP growth. Because U.S. GDP shrank by -1.5% in Q1 2022 (January to March), a lot rests on the Q2 figure (April to June) which should be released on July 28th.
Referencing strong business activity and continued growth in consumer spending, economists predict that U.S. GDP will grow by +2.1% in Q2. This would mark a decisive reversal from Q1, and put an end to recessionary fears for the time being.
Unfortunately, inflation is the top financial concern for Americans, and this is dampening consumer confidence. Shown below, the consumer confidence index reflects the public’s short-term outlook for income, business, and labor conditions.
Falling consumer confidence suggests that more people will delay big purchases such as cars, major appliances, and vacations.
2. The COVID-era housing boom could be over
Housing markets have been riding high since the beginning of the COVID-19 pandemic, but this run is likely coming to an end. Here’s a summary of what’s happened since 2020:
- Lockdowns in early 2020 created lots of pent-up demand for homes
- Greater household savings and record-low mortgage rates pushed demand even further
- Supply chain disruptions greatly increased the cost of materials like lumber
- Construction of new homes couldn’t keep up, and housing supply fell to historic lows
Today, home prices are at record highs and the cost of borrowing is rapidly rising. For evidence, look no further than the 30-year fixed mortgage rate, which has doubled to more than 6% since the beginning of 2022.
Given these developments, the drop in the number of home sales could be a sign that many Americans are being priced out of the market.
3. Don’t expect groceries to become any cheaper
Inflation has been a hot topic this year, especially with gas prices reaching $5 a gallon. But there’s one category of goods that’s perhaps even more alarming: food.
The following table includes food inflation over the past three years, as the percent change over the past 12 months.
|Date||CPI Food Component (%)|
From this data, we can see that food inflation really picked up speed in April 2020, jumping to +3.5% from +1.9% in the previous month. This was due to supply chain disruptions and a sudden rebound in global demand.
Fast forward to today, and food inflation is running rampant at 10.1%. A contributing factor is the impending fertilizer shortage, which stems from the Ukraine war. As it turns out, Russia is not only a massive exporter of oil, but wheat and fertilizer as well.
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