GameStop (GME) Rally Could Be One-Day Wonder

GameStop Corp. (GME) shares surged to a 20-month high last week after the company entered into a multi-year strategic partnership with Dow component Microsoft Corporation (MSFT). However, the collaboration doesn't involve Xbox or the Mr. Softee's vast video gaming library, despite the intriguing headlines. Rather, the brick-and-mortar retailer will standardize business operations on the Microsoft cloud and add a plethora of business, collaborative, and customer data collection tools.

Key Takeaways

  • GameStop will use Microsoft productivity software throughout its organization.
  • GameStop stock has lifted into nearly impenetrable resistance.
  • Rally buyers could get trapped in a steep decline.

The strong buy-the-news reaction suggests that speculators view GameStop as a potential takeover target, but there's little evidence of that intention in the news release. In addition, Microsoft already ran into a dead end attempting to compete with the Apple Store, announcing in June it would close all 83 Microsoft Store locations. The company tried to save face at that time, saying it was a "strategic change" triggered by the shift to online sales and services.

Not one analyst stepped forward with an upgrade after the partnership news, but Jefferies downgraded GameStop stock from "Buy" to "Neutral" due to valuation concerns. In addition, GameStop shares had doubled in price between August and the day prior to the announcement, raising the odds that insiders had picked up shares ahead of the news. It's no surprise that the rally ended with a high-volume reversal after a single session, suggesting that the same folks were taking opportune profits.

Wall Street consensus on GameStop now stands at a "Hold" rating based upon just one "Buy," five "Hold," and two "Sell" recommendations. Price targets currently range from a low of $3.50 to a Street-high $13, while the stock traded two points above the high target before the reversal. This placement lowers the odds for higher prices, while newly minted investors could get caught in a reality check that drops shares back into the single digits.

Insider buying is the purchase of shares in a corporation by a director, officer, or executive within the company. Insider buying is not the same as insider trading, which refers to corporate insiders making illegal stock purchases based on non-public information.

GameStop Long-Term Chart (2007 – 2020)

Chart showing the share price performance of GameStop Corp. (GME)

Shares of the retailer ended a multi-year uptrend at an all-time high in the mid-$60s in 2007 and fell to a seven-year low in the mid-teens in 2012. A 2013 recovery wave stalled about six points below long-term resistance, yielding a two-year consolidation pattern, followed by a return trip to the 2012 low that completed a massive double top. It broke down in the second quarter of 2019 and posted an all-time low at $2.57 during the first quarter's pandemic swoon. 

Price action between the summers of 2019 and 2020 carved a basing pattern, ahead of an August breakout that has established new support around $6.60. The buying spike into October reversed at the descending 50-month exponential moving average (EMA), which was broken on heavy volume in 2015. In addition, the uptick also reversed within 52 cents of the 2012 low, with both levels forming a nearly impenetrable barrier that raises the odds for a quick end to the recovery effort.

Finally, the monthly stochastic oscillator has lifted into the overbought zone for the first time since 2015, highlighting the strong buying surge. Indicator lines are still in a fortuitous position, suggesting that price action will take time to form a top before a major retreat. However, unless GameStop and Microsoft specifically state that their partnership is more than the sum of its parts, upticks should probably be used to lighten up on long-side exposure.

Overbought is a term used when a security is believed to be trading at level currently above its intrinsic or fair value. Overbought generally describes a recent or short-term movement in the price of the security, and it reflects an expectation that the market will correct the price in the near future. This belief is often the result of technical analysis of the security's price history, but fundamentals may also be employed. 

The Bottom Line

GameStop surged to a 52-week high after announcing a Microsoft partnership, but adverse technicals predict that the recovery wave will fail quickly.

Disclosure: The author held no positions in the aforementioned securities at the time of publication.

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