Trading Salience in a Hyperconnected Marketplace (Part 1)
Unlike most of my posts, this will veer largely into philosophy and maybe some poorly interpreted behavioral economics. As I have a computer science and business background, this of course qualifies me as a subject expert on both of those topics.
As I’ve mentioned before, I’m fairly new at trading in general — although I’ve invested for many years - which brings both some downsides (a lack of perspective on historical trends) and upsides (potentially a novel lens). However, similar to most of my generation, I am a true native of the internet, learning to type slightly after learning how to walk. And what that means is I love memes.
Memes are much older than the internet, though. The term meme originated humbly from Dawkins’ The Selfish Gene, as the British biologist looked to understand social trends and behavior through the lens of Darwinian evolution. A meme simply is an idea or cohesive theme, spreading from person to person, usually through some medium of communication. This can run the gamut from a big picture idea like religion to, well:
What’s interesting though about memes in general is they tend, much like genes, to simplify in complexity over time. In general, memes that harken back to a simple symbolic idea (feeling depressed, overwhelmed, popular cultural icons like Baby Yoda, cats being cute) tend to survive the longest, eventually achieving fixture status (even if they may be vintage or unpopular by now, like lolcatz). This is analogous to a game of telephone (or, for the more biologically minded, replication and mutation) — at each step of transmission, there is some loss of information, and the ideas that can be compressed the best tend to remain while others fade into the aether.
Okay, but what does this have to do with investing?
The Shower Index
Way back in my trading infancy, I realized subconsciously a clever game I called the Shower Index, where I would simply pick ticker names that came to me in the shower. There were some basic rules here:
- It had to be truly random. This means, I would make sure that nothing conscious influenced my decision of a ticker. Usually this meant discarding obvious choices, and coming up with weird callouts ($TSN, $SWBI, $FNKO, $CAKE come to mind).
- It had to be in the shower. This was to clear my mind as much as possible, my own stress-free zone.
Unsurprisingly, this year, the Shower Index in September 2020 (when it started) well outperformed any major index, at times even beating $BECKY (a hypothetical index made up of women’s-focused companies) and $UW (an index made of consensus choices from members of the Unusual Whales discord).
Suffice to say, I looked pretty cool in my predictive accuracy. In general, for some reason or another, tickers picked out of the aether seemed to work.
The Power of Narrative and the Meme
Most of us by now have heard, in some way or another, of the WallStreetBets forum on reddit, a 2 million man army of risk-loving gamblers who recently decided to take on long/short hedge funds (like the vilified Melvin Capital) and won, largely through (intentionally or not) weaponizing the 0 day long call option.
As the latest short interest annihilating frenzy shows, together even the oft-vilified/ignored retail segment has real power in a game traditionally reserved for institutionals, especially when collectively focused and using rather insane amounts of leverage.
But, as I touched on briefly in my post, why Gamestop? Or for that matter, why Palantir, Blackberry, Nokia, or Tesla or any of the other memes de jour which have seen the force of concentrated gamma?
It has to do with the power of narrative. As mentioned in my prior post, the narrative of Gamestop (ignoring the value trap or short squeeze narratives which drew in early, high-information traders) is both compelling and simple:
- A cataly-ish: This actually isn’t a required part of the narrative effect, but tends to help and provide a sense of urgency and organization. In general, humans prefer binary catalysts — events where there’s solely a positive or negative outcome. This tends to almost gamify the situation, including attracting risk-loving market participants (who tend to use the weaponized options discussed prior). However, in terms of constructing a narrative any catalyst will do, including minor (for instance, Microsoft’s supposed partnership with Gamestop — the initial catalyst for its meteoric rise) or completely fabricated ones will do.
- Salience: This is by far the most critical part of narrative assembly, given the force of meme as previously discussed. As an idea is rapidly transmitted through a medium and replicated, it tends to lose all but its most defining characteristics. This is why, for instance, in online echo chambers — Parler, for example — ideas tend to reduce to more extreme, basal forms, crystallizing on human emotion (in the case of conspiracy theories, distrust and anger) and captivating followers even against common sense. You don’t need rationale or evidence or even really strong due diligence if a ticker has enough salience. As a thought experiment, let’s look at the current zeitgeist (attacking stocks with high short interest).
Given the current zeitgeist, it would be reasonable to imagine that there would be a strong correlation today between percentage of short interest (as given by https://www.highshortinterest.com/) and percentage increase in share price.
We can clearly observe that at its peak today, iRobot moved about 40%, while Ligand Pharmaceuticals moved roughly 11%. Despite this, short interest is about double on Ligand. Why is that?
Simply put — the narrative effect here dominates. Despite the naivest interpretation (speculators are hoping to replicate the potential short squeeze observed on Gamestop), in the real world low-information investors (most daytraders, for example) tend to gravitate towards names with high memorability. Everyone remembers the Roomba; few people even know what a ligand is.
This is a key point, and this is my interpretation of why the Shower Index thought experiment works. In general, it isn’t the aether or the idea of picking a truly random ticker that matters — what matters is the concept of picking them in the shower, from your own mind. Your mind, whether consciously or not, organizes information according to salience, and the tickers you may pick “at random” are, in general, the most memorable tickers to you. If you’re an internet denizen even better — those tickers likely not only have high salience to you, but to just about everyone else. When a trend hits, they’re first to pop (and usually first to drop as well).
Finally, this isn’t some Lily-ism or novel concept. It’s a well known effect (and largely contradicts the idea of an efficient market) that tickers with memorable, funny names outperform. Again, salience.
Gamestop and Tesla, in my opinion, represent some of the strongest examples of salience (and therefore meme power), although for largely different reasons:
a. Gamestop (Brand Recognition, Nostalgia) — Much like everyone else, I’ve always been tangentially aware Gamestop exists, ever since I used to buy consoles and video games as a young kid from there. Most of us have funny anecdotes of hating the store for their draconian refund/credit policies, as well as being the butt of most retail jokes (along with Sears) since about 2010. However, in the same light, it also presents nostalgia to my generation — it reminds us of a time before the Great Recession, before Donald Trump, before the world got extra weird. Subconsciously, there’s an emotional attachment, which much like the rise of early-2000s fashion again helps us understand why literal fossils ($BB, $GME, $NOK to name a few) are suddenly in speculation vogue again.
b. Tesla (Reality Distortion, Optimism, ESG) — Tesla’s rise, at least in hindsight through a narrative lens, seems less like an extraordinary occurrence and more like a predestined fate. Despite his extremely unconventional and perhaps ill-befitting-of-a-CEO antics, Elon Musk knows and loves the internet, and the internet loves him back. Like Steve Jobs, Musk through his escapades has established in many ways a monomaniacal cult — for most Tesla diehard investors (and some Tesla buyers), they aren’t investing in a company with fundamentals, they’re investing in the concept of Elon himself. Even at inflated valuations, far outside any realm of sanity with conventional modeling, Tesla’s price remains strong. I’d argue this has to do with the innate desire for social good, and Tesla’s prime mover advantage in a world struggling to act on the encroaching deadline of climate change. Investing in Tesla not only makes you money, but it feels good, because at least according to the simplified narrative, it is social good. You are investing in a better future, so of course it makes sense at any price.
3. Humor: If you’re tracking on the concept of salience as a determinant for stock success, the idea of humor as integral to the story should come as no surprise. In general, humans tend to remember humorous information far better and more accurately than non-humorous information.This provides a supporting base to salience — a narrative, funny to its core, propagates as a meme much more quickly and for far longer than an unfunny one. This again relates to the Tesla:
and of course, the idea of Gamestop, Blackberry, iRobot, and Nokia as the hottest technology stocks of 2021. Additionally, it acts as a self-defensive mechanism for propagating information online — it’s a lot easier to present a stripped down story, or provide incomplete or spurious reasoning for investing in a stock if well, it’s fucking funny.
Gilgamesh, Roaring Kitties, and Ryan Cohen
This brings us to our last point: the story itself. Humans again are narrative driven creatures, and nothing beats a good story for the initial motivation (reading the initial post on a forum, for example), recall, and finally action.
In the Gamestop narrative, four key players quickly captivated the attention of the masses:
- /u/DeepFuckingValue (DFV) (the Youtuber TheRoaringKitty)
- Ryan Cohen (Former Chewy founder)
- Melvin Capital (Long/Short Hedge Fund)
- “Boomer” George Sherman (CEO of Gamestop)
In this saga, we can quickly segment the key players into two roles:
- The Hero: DFV, Ryan Cohen
- The Villains: Melvin Capital, George Sherman
In the most successful stories (e.g. religion, national mythos, etc.) academics have identified common templates. These often are recycled throughout time and place, and serve as the skeleton for transmitting morals, ideas, and civics between generations in a compelling, entropy-resistant way. One of the most famous examples of this is the monomyth, also called the Hero’s Journey:
In its most basic form, the Hero’s Journey consists of a call to action, as an ordinary person (or perhaps a demigod) is taken on an adventure to a more fantastic world, often tested through battle or tragedy. This usually ends on an upbeat note after the hero hits a nadir, where they vanquish their foe and receive the gift of a supernatural entity and finally return home.
Sounds familiar? This is a staple of the human narrative, spanning from modern storytelling (Star Wars) to the most ancient stories recorded (The Epic of Gilgamesh). It is both incredibly formulaic and incredibly salient, hitting on the most basal of human emotions and desires (adventure, greed, love, tragedy, the supernatural).
How does this relate to the Gamestop, though?
Assembling a Narrative
Gamestop, before the summer of 2020, was a hushed whisper primarily in value investing circles. While it was long known to be a value play (or more accurately, a value trap), it did not inspire much interest, even when the massive short interest was known (short interest is public information provided bimonthly from FINRA).
But then this guy came along.
In September 2019, a user by the handle of DeepFuckingValue started posting screenshots of his massive Gamestop positions (about $53,000 initial investment) on WallStreetBets. At the time, it was met by little fanfare, and for months it seemed to be a massive, ill-advised joke:
By himself, DeepFuckingValue was an ordinary dude (in fact, no one knew at the time he was a fairly popular Youtuber named TheRoaringKitty). While many looked upon his gambit with interest, few took heart to join, specifically because, well, he was betting on a dying brick-and-mortar retail in the middle of the worst pandemic in 100 years.
In this narrative, DFV craftily set the groundwork for the meme as the willing hero, who took the Call to Action while still remaining in the mortal world.
This all changed, however, when Ryan Cohen joined the scene through his activist investor firm RC Ventures in August 2020. If you’re still tracking, Ryan Cohen’s appearance on the scene was manna for the narrative of Gamestop — a young, eccentric billionaire with a proven track record of establishing successful companies (Chewy) in rather unsexy spaces.
We can see how the stock reacted:
As the months passed, the legend of DFV in WallStreetBets started to grow with his portfolio size, as people hopped aboard the Gamestop train in a series of catalyst-propelled jumps, the first being Microsoft’s announced deal with Gamestop on October 8th, 2020. Despite being a fairly small, asymmetric partnership, this absolutely validated the narrative of a turnaround story to the low-information speculators, resulting in a daily jump of over 50%.
Similarly, our hero’s journey was propelled along the way by the sectoral trend giving Gamestop favorable headwinds — the 2020 console cycle. While a laggard in ecommerce compared to much larger rivals (e.g. Amazon) Gamestop’s stock jumps noticeably coincided with the last few console cycles, as clearly seen here:
During our journey, a confluence of factors seemed to emerging — a salient turnaround story, an iron-willed hero (DFV), and a magical billionaire mentor (Ryan Cohen) who would grant riches to all those who followed along the way.
In December 2020, all eyes were on Gamestop’s winter earnings release. Sitting around $17/share (a respectable 300% up from 2020 lows), Gamestop bulls needed a strong earnings report to validate their thesis, and help propel Gamestop to be the MOASS (Mother of all Short Squeezes). And we all watched, and, unsurprisingly, it fell flat, crashing almost 20% after the report.
To add insult to injury, Gamestop announced a shelf offering as part of its earnings release, filing to sell up to $100 million more in equity. Bulls were deflated, and all hope seemed lost for the Gamestop narrative.
Around late December, Gamestop stock sat wistfully in the high-teens, bolstered by the approaching faux catalyst of a technology conference and cheered on by 300% growth in e-commerce (forgetting to mention of course, a decline in total revenue in the same time period). By now, a cult had largely assembled around DFV, and denizens of WallStreetBets looked towards his daily (or weekly) portfolio update posts to provide them courage to weather the bearish storm.
And then, again the gods dropped manna. Despite the cancellation of Gamestop’s appearance in the conference (which of course, was later decided to be a good sign by the bulls), Gamestop announced the appointment of Ryan Cohen to the board in mid January 2021. And that’s when it exploded.
I could continue onwards, and story-writing is fun. As much fun as it is to narrative the saga of Gamestop, I wanted to highlight its similarities to the mono-myth, and why Gamestop versus competing memes (like LAZR, NIO, tanker gang, silver, etc.) has withstood the test of time (months, in internet terms). Gamestop, much like Tesla, was a simple story, centered around a hero each of us could personally identify (the anonymous account), armed with the help of the supernatural (a billionaire pet food guy) against a reviled foe (the hedge funds and Wall Street). It could not have been more perfect.
I’m going to stop here for today, and in the next part expound on the narrative and the mind web. It’s my humble opinion that understanding the impact of the narrative will be a critical component of investing (it has always been a mainstay in venture capital, for example, except for economic downturns) going forward. With the increasing participation of retail and the penetration and hyper-connectivity of the online world, the narrative will, at least for a time, dominate. Understanding it, therefore, seems critical to investing success.