There is plenty of discussion of why the US stock market has been so strong, but that can be left for another time. (There is an acronym, TINA, which means “there is no alternative” to the stock market for investors these days.) That strong market, however, has led to a number of developments which are of concern to any seasoned market participant. And we have been here many times before.
The rage on Wall Street is the “blank check” company (formerly known as a special purpose acquisition company, or SPAC), which is an investment vehicle that goes public but has no real business, just a goal of using the funds to buy a private company to be chosen later. A record $31.6 billion has been raised already this year, more than double the $12.4 billion in all of 2019, which was the previous record. These funds typically raise money at $10 a share, but 11 of the 18 companies that merged with a SPAC in the past year are trading at less than $10. And as usual, the fund managers are making their fees with each transaction.
At the same time, the SEC has broadened its definition of “accredited investors”, or those who are qualified to invest in hedge funds, leveraged buyouts, start-ups and other types of illiquid and high-risk ventures. Previously, an accredited investor had to have either $1 million in net worth (excluding their home) or at least $200,000 in annual income. (Those amounts have not been indexed for inflation, and as a result the accredited investor pool grew from 1.31 million in 1983 to 16 million in 2019.) Now, individuals with certain credentials or who are “knowledgeable employees” are accredited regardless of their financial situation. Not surprisingly, the change was led by private-market players who claim it is not fair to deny access to these investments based on financial status alone, all the while raising record amounts of money on which they earn handsome fees.
In another example of expanding access, the trading app Robinhood has exploded in popularity by using design elements that influence user behavior. Investors can buy a partial share of stock on Robinhood, at no transaction fee, but this is already possible through more established brokerage firms. Robinhood uses bigger and brighter buttons that make it easier to buy a stock than to cancel a trade, offers a trial run with free stock and nudges users to repeat behaviors and buy stocks based on other users’ purchases. The app claims to break down the idea that investing is only for the wealthy or highly educated and to help customers learn and invest responsibly. This “gamification” of investing, however, obscures the inherent risks. (In an example from the Wall Street Journal, a new user who had never invested before, and a friend who texted her a referral link, each received a free share of Macy’s. This new user now spends as much as five hours a day trading penny stocks on her phone.)
The scariest changes, though, are found in a Yahoo-Harris Finance Poll of 1,000 Americans from Sept. 4 to Sept. 6. The same percentage (33%) of people who own stock indicated they have been trading stocks more since the pandemic began and are trading individual stocks more as opposed to ETF’s or mutual funds. Lower income households are trading more than both middle- and high-income households. Trading risk is amplified, with 43% of respondents using leverage (borrowing money using other stocks as collateral) and/or options (profiting from price changes in a stock without owning the stock outright), both of which magnify gains and losses compared to just buying and selling the stock.
This is not in any way a prediction of whether the stock market will suffer a swift decline or how it will perform going forward. It is, though, a prediction that uninformed, speculative “investing” will end badly and at great cost for most participants. Initial success is the worst thing that can happen, as it emboldens bad behavior and often leads to bigger bets, with disastrous results. And for those who end up profiting, luck and riding the wave of a rising market should not be confused with skill.
The slow and steady approach to investing still offers the highest likelihood of success. If someone really wants to gamble with their money, they are better off going to the horse races than gambling on stocks. They will have a similar, and probably better, chance of winning, they will see some beautiful animals, and they will get a boost of vitamin D if it is a sunny day.