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Gamestop Suffers From a Rising Volatility Index and Market Efficiency

The driving force behind Gamestop’s (NYSE:GME) initial community-driven surge has been down to an overly liquid market and analysts’ event-driven predictions. Moving forward, though, investors will want to understand why the influ…

The driving force behind Gamestop’s (NYSE:GME) initial community-driven surge has been down to an overly liquid market and analysts’ event-driven predictions. Moving forward, though, investors will want to understand why the influencing variables of GME stock will be subject to change.

Source: rblfmr / Shutterstock.com

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At this stage, I’d imagine that readers aren’t entirely sure what to believe with GME stock. There’s a dearth of accurate information when it comes to meme stocks. Thus, the argument behind this article is aligned with firm theoretical underpinnings as well as anecdotes based on my previous experiences with pricing wildly speculative assets.

Here’s what you should know about GME stock moving forward.

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GME Stock and the Impact of Volatility

For GME stock, it may be best to start off with a technical approach. After all, the stock has been somewhat disconnected from its fundamentals, to say the least.

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So, GME from a technical view? GameStop stock has established a noticeable negative correlation with the CBOE Volatility Index (VIX). This suggests investors aren’t willing to rest their money on it during a broad-based market downturn.

Source: Gurufocus

Source: GuruFocus

Looking forward, we’re likely to experience continued volatility. An abrupt change in monetary policy is upon us, with analysts expecting up to seven interest rate hikes this year. Furthermore, pandemic-induced industry changes have prompted uncertainty among investors, causing a lot of sector rotation in the markets. JPMorgan analyst Gabriela Santos had the following to say:

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“Volatility is going to stay higher for longer […] We only project beta returns going forward of 4.3% annualized. So we got to work harder to generate the same returns as the last cycle. And that’s where alpha comes in.”

The knock-on here for GME stock is that risk-on investors will probably run for the hills once they see the broad-based indices struggle to find direction. That’s what has been conveyed by the VIX thus far. 

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Fundamentals and Market Efficiency

The efficient-market hypothesis is a term most of you have probably heard during the meme craze. Still, I feel as though many don’t quite understand what market efficiency means. I’d like to explain this by contextualizing investor utility cycles. 

Stock market participants will continue to invest as long as their expected returns for their given levels of risk are met. This is why we see momentum patterns form and collapse, time and again. Thus, the broader market constantly drifts away from and regains a form of market efficiency.

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So, how do we gauge this? We can use the S&P 500’s price-earnings (P/E) ratio. The P/E ratio essentially provides us with a function of a stock’s market price relative to an investor’s residual claim. We’ve seen the market drift away from efficiency during the pandemic as an ultra expansionary monetary framework entered the picture. However, within the past few months, the S&P 500’s P/E has decreased from 39.9 in December 2020 to around 25.0 today. That is still considered much higher than the index’s equilibrium range between 13.0 and 15.0, but it does convey that the market is seeking stocks with more robust fundamentals in an attempt to regain efficiency.

GME stock could be one of the big losers during this readjustment process because of its flimsy underpinnings. Sure, the stock has experienced a short squeeze and been traded with everything non-related to the company itself. But we need to account for variable change, meaning that its influencing factors will change linearly with time.

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Observing the dynamics of GME stock, it’s hard to argue its demand will rise in an efficiency-seeking financial market. Video game sales have been falling for a few months now, with a 2% decline in January. That’s significant considering retail sales rose by 3.8% over more or less the same period. Furthermore, GME is facing headwinds from a consumer base that’s looking more towards staples as inflation dampens economic growth overall. A shift in the consumer cycle could hurt meme stocks because they’re already trading on shaky foundations with artificially inflated prices.

The NFT Argument

The final matter to consider for GME stock is the non-fungible token (NFT) argument. Right now, the reality is the NFT space looks set to stay, but with any hot prospect comes fierce competition.

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That subsequently causes the new “idea” to lose its company-specific value-add for GameStop. The consequence of this? The market starts pricing the asset on how well it thinks the idea can be financially validated instead of how revolutionary it is.

Need an example? We saw this happen with Meta Platforms (NASDAQ:FB) when it cratered more than 30% after the company reported lower-than-anticipated revenue from its metaverse segment.

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What Now for GameStop?

So, what should investors do with GME stock?

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All told, I don’t think it’s the right time to take a risk on a stock that has been driven by anything but solid fundamentals. Yes, GameStop is pivoting to NFTs and building a few key partnerships to modernize its business. But the fact remains that the market is running at high volatility and calling out for efficiency. That doesn’t look good for GME.

On the date of publication, Steve Booyens did not hold any position (either directly or indirectly) in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.

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Steve Booyens co-founded Pearl Gray Equity and Research in 2020 and has been responsible for equity research and PR ever since. Before founding the firm, Steve spent time working in various finance roles in London and South Africa, and his articles are published on various reputable web pages such as Seeking Alpha, Benzinga, Gurufocus, and Yahoo Finance. Steve’s content for InvestorPlace includes stock recommendations, with occasional articles on crowdfunding, cryptocurrency, and ESG.

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