Stock-specific speculation has stirred up markets in recent months. Reddit is a much talked about social bookmarking platform, which attracts people in a forum-like setting. As a collective, users have been actively discussing stock opportunities and engaging in a ‘Main Street v Wall Street’ debate.
Some individuals are putting their money where their mouth is – and we have seen some selected small stocks suddenly spike tremendously, then fall spectacularly. It is like watching the price of any speculative asset – for example, bitcoin – and the market can bounce around without much fundamental reason.
Specifically fuelling the speculation around these stocks were individual traders. We see two trends here. First, social media such as Reddit’s WallStreetBets and other platforms drove much of the trading of these selected stocks, according to reports. Some sought to squeeze shortsellers, while others were just hopping on a fast-rising stock in the hope it would keep going up.
‘Gamification’ elements
The other trend is the rise of low-cost, commission-free trading and apps, such as Robinhood in the US, which adds ‘gamification’ elements that can serve to encourage more trading, especially among younger, inexperienced traders. Elevated trading that seems to be entirely disconnected from underlying fundamentals does not sound like a formula for success for a long-term investor.
Nevertheless, we do not see large implications or major risks at this point for most investors. Instead, we expect these to be blips that do not affect most investors as these tend to be small stocks that, even after rising 1,000% or more, do not constitute much of the US market. Assuming their prices return to more normal levels, they will not become part of major indexes.
That said, this is an unfortunate introduction to the market for a new generation. The attitudes of some market participants, who seem to view stocks as get-rich-quick schemes, is also somewhat concerning. This perhaps started recently with the atmospheric rises of bitcoin and fast-growing technology stocks, turning some folks into millionaires (at least on paper).
‘Next pot of gold’ thinking
Now there seems to be a hunt for ‘the next pot of gold at the end of the rainbow’ – the type of thinking we tend to see more of just before a major market correction. That is not to say this latest activity points to an imminent crash – to say so would itself be speculation.
Still, time and time again, we have seen that many people eventually end up losing everything when joining a speculative frenzy – see Tulip mania in 17th Century Holland, the Roaring 20s, Nifty Fifty, dotcom bubble, Great Recession and so on and so on. This is especially true for novices buying on margin. To make matters worse, many losers often swear off making future investments and miss the potential for building wealth slowly with a more prudent approach.
How might this affect investors in multi-asset portfolios? We are watching the Reddit WallStreetBets circus from a distance – certainly not participating but with an eye toward assessing whether this social-media-driven volatility is a new risk in the markets, or just the same thing we have seen in past manias (and 1999 Yahoo chat rooms) in a 2021 wrapper. We look for portfolio managers who have years of experience and follow investment philosophies grounded in fundamental research, with the ultimate aim of determining an asset’s true value.
Greater fool theory
We are not in the business of investing on the basis of ‘Greater fool theory’, which bets on the possibility that a greater fool might pay an even higher price for a company’s stock. We are especially not interested in moribund companies’ stocks bid up by a frenzied crowd where the underpinning is a technical dislocation, such as a short squeeze.
Put simply, investors should not treat the market like a game of Candy Crush. Rather, it is important to stick to an enduring philosophy and disciplined approach to investing. Aim to build wealth for our clients, not by frequently trading, but by seeking to be long-term owners of profitable and cash-generative assets.
Investing is challenging and markets are competitive. Professional fund selectors will not be right on every call, but we will spend hours of dedicated research, analysis, and reflection on every investment made. We also employ our education, credentials, and years of experience, not to mention a small army of analysts, in this endeavour.
Ultimately, investors must humbly enter the ring – that is to say, markets – with great respect for their opponents (other investors) while striving to maintain their independence. If individual investors are eager to step into the fray, so be it. Generally speaking, however, times like this tend to underscore why novice investors should consider hiring a specialist who can recommend an appropriate investment strategy that will help them reach their financial goals.
Leslie Alba is associate director, research, EMEA at Morningstar Investment Management Europe
