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Valuations Reminiscent of Dot-Com Crash in 2000: Part II

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By Andrey VP @ Shutterstock.com

You read yesterday about the online forums where traders are encouraging each other to invest in stocks, and creating a tug of war between them and hedge fund managers that is driving some stocks to dot-com bubble level valuations.

The trading storm created by these online rumor mills is taking a toll on online trading platforms, report Justin Baer and Peter Rudegeair in The Wall Street Journal. They write:

“These outages generate annoyance among investors in the short term,” said William Trout, director of wealth management at Javelin Strategy & Research. “Longer-term, outages call into question the stability of these platforms, even if the need for greater capacity can be addressed.”

The outages also can take their toll on the markets themselves, especially at a time when individual investors’ interest in stocks has touched levels unseen in decades, he said. Robinhood Markets Inc. and other popular trading platforms experienced outages last spring, when concerns over the pandemic and its effect on the economy triggered the worst stock-market selloff since Black Monday.

The market snapped back almost as quickly, drawing in many first-time stock traders. And with many Americans transitioning to remote work, those investors had more time to pore over their brokerage accounts and place their bets. Their enthusiasm, along with efforts by brokers to beef up their platforms, so far has offset clients’ frustration with temporary outages. But repeated problems will test their patience and draw regulators’ attention, Mr. Trout said.

“The surge in self-directed investing amid Covid has made these online platforms a centerpiece of the investments landscape,” he added. “As infrastructure becomes a core issue, the markets—or the regulator—will demand reform. Reliability of these platforms and investor confidence have become interlinked.”

During the retail-trading boom of 2020, volume at many big brokerages shattered records. The average daily number of retail trades on E*Trade, which was acquired by Morgan Stanley MS -1.62% last year, hit 952,000 in 2020, more than triple its previous annual high point. Schwab set, and broke, multiple single-day trading records in 2020, setting a new peak on Nov. 9 of 7.8 million trades.

The number of active retail-trading accounts also swelled. In the second half of 2020, E*Trade added about 900,000 net new accounts, bringing Morgan Stanley’s total to 6.7 million. Following the close of its acquisition of TD Ameritrade Holding Corp. in the fourth quarter, Schwab counted nearly 30 million active brokerage accounts at the end of 2020.

Action Line: If you are trusting your investments to the rumors in Reddit message boards, pushed by kids who weren’t alive in the dot-com era, and barely remember the Financial Crisis, take heed. Now is the time to find a fiduciary who has experienced multiple manias and can help you achieve your investing goals.

P.S. The Wall Street Journal’s James Mackintosh calls GameStop’s recent price action a “bubble in its purest form.” He writes:

A combination of easy money, a real improvement in the company’s prospects, technical support from a short squeeze and a mad rush to get rich or die trying pushed stock in the retailer up almost 70-fold from August to this morning’s premarket high. Anyone who held for 10 days made gains of more than 10 times their money.

It is tempting to see GameStop as merely clownish behavior in a chat room having some amusing effects on a stock few care about. That would be a mistake.

Sure, the wildly popular Reddit group Wall Street Bets—slogan: like 4chan found a Bloomberg terminal—is full of childish chat. Several users report that they have bet their parents’ pension fund on GameStop or that the boss’s daughter has bought in. There are plenty of calls for the stock to go to $1,000 or more (it started the year at $18.84).

But GameStop’s soaring stock—and similar moves in BlackBerry, Nokia and others—is a bubble in microcosm, with lessons for those of us worrying about froth elsewhere in the market.

GameStop’s rise started with some genuine good news, just as bubbles always do. Ryan Cohen, who built up and sold online pet-food retailer Chewy, started building what is now a 13% stake for his RC Ventures in GameStop last year. He pushed for the staid mall-based seller of videogames to improve its internet sales. This month he joined the board.

Mr. Cohen’s arrival means GameStop at least has a chance of joining the 21st century. From the first disclosure of his stock purchases in August up to the end of November the shares tripled, helped too by the improved prospects for the vaccine-driven reopening of the economy.

Along the way, some private investors latched on to the stock, helping its rise, and it became an item of discussion on Wall Street Bets, or r/WSB as it’s known.

This month the stock moved into the pure speculative phase, producing several daily jumps of 50% or more, and fundamentals were abandoned. Many cheerleaders on r/WSB stopped even making the pretense of arguments about Mr. Cohen’s chances of turning the company around. Instead, there were two justifications for buying: wanting to get in on the price action to avoid being labeled, in the abusive parlance of the forum, a “retard” who missed gigantic profits, and the self-fulfilling prospect of hurting the large numbers of short sellers.

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E.J. Smith - Your Survival Guy

E.J. Smith is Founder of YourSurvivalGuy.com, Managing Director at Richard C. Young & Co., Ltd., a Managing Editor of Richardcyoung.com, and Editor-in-Chief of Youngresearch.com. His focus at all times is on preparing clients and readers for “Times Like These.” E.J. graduated from Babson College in Wellesley, Massachusetts, with a B.S. in finance and investments. In 1995, E.J. began his investment career at Fidelity Investments in Boston before joining Richard C. Young & Co., Ltd. in 1998. E.J. has trained at Sig Sauer Academy in Epping, NH. His first drum set was a 5-piece Slingerland with Zilldjians. He grew-up worshiping Neil Peart (RIP) of the band Rush, and loves the song Tom Sawyer—the name of his family’s boat, a Grady-White Canyon 306. He grew up in Mattapoisett, MA, an idyllic small town on the water near Cape Cod. He spends time in Newport, RI and Bartlett, NH—both as far away from Wall Street as one could mentally get. The Newport office is on a quiet, tree lined street not far from the harbor and the log cabin in Bartlett, NH, the “Live Free or Die” state, sits on the edge of the White Mountain National Forest. He enjoys spending time in Key West and Paris. Please get in touch with E.J. at ejsmith@yoursurvivalguy.com