If You Think Investment is a Game, Stop.
A pin lies for every bubble and when the two meet,
a new wave of investors learn some very old lessons.— Warren Buffett
When looking at irrational herd-like behaviour, psychoanalysts refer to a process called “splitting” — where individuals, unable to cope with its own good and bad qualities simultaneously, “splits” the bad ones off and attributes them to other people. What emerges is an exaggeration of one’s own virtue and innocence, and a similarly exaggerated picture of the selfishness and corruption of others. Unfortunately, social media exacerbates this, making the world seem neatly split into good and evil.
Financial news was recently awash with the extraordinary rise of the stock of a company called Gamestop. The underlying narrative was compelling — a big group of retail investors organised through a forum on Reddit bought up shares of the company in order to bankrupt some billion dollar hedge funds who had bet the opposite way. A classic David versus Goliath story. The activity made headlines on media across the world which resulted in even more people jumping to invest in the company. Many put their entire life savings into the stock in order to “defeat evil Wall Street”.
Might there be bigger issues at play with this seemingly crazy behaviour? There has been a large underlying resentment amongst many who have posted on the forum declaring how hedge funds and the financial system failed them during the 2008 Global Financial Crisis. Many lost their jobs and homes and took years to find their feet. This seemed like the perfect revenge.
Before even thinking about jumping into the fray, why not take a step back and consider what caused the phenomenal price appreciation of Gamestop and a handful of other stocks pushed by the Reddit forum? Especially when there is no significant news nor change to their fundamentals.
A good place to start is with stock prices. People tend to forget that what they buy on the stock market is ownership in companies — it is nothing like a Toto ticket. Prices reflect expected future cash flows of these companies. If a stock’s price goes up, it means the expectations of future cash flows have increased. In the event that these expectations are irrationally/erroneously justified, the stock price moving higher would actually mean lower expected returns.
There is a distinct difference between investing and speculation. If you were to buy a company, would you hold onto it for only 2 or 3 days? Imagine buying a company of a local kaya toast franchise. We are quite sure that you would be prepared to invest your money for nothing less than a year, let alone a few days. With the speculation similar like what’s been happening over the past few weeks, speculators are betting that someone will buy the shares from them at a higher price. The Greater Fool Theory comes to mind.
Markets have rewarded investors (not speculators) who take a long view and follow empirical evidence based concepts when investing. Setting clear investment goals, ensuring that your portfolios are well-diversified across asset classes and regions, and targeting the drivers of returns will ensure you achieve investment success. Speculation has destroyed many more fortunes than it has created. The shares of Gamestop that have shot up so quickly will eventually find their equilibrium and come back down to earth.
The diagram is reminiscent of so many other bubbles which have preceded it. After hitting a high of $469 in end Jan, it is trading at $50 at the time of writing. Such fluctuation and volatility is no way for you to invest your retirement savings, or the money you’ve set aside for a home or a child’s education. To ensure that you are investing in a right manner, or to simply have a second opinion on your finances, come and speak with us.
