The stock market is a big place with thousands of investments that you can make as an investor. It’s a frustrating place. There is a myriad of investing disciplines that you can seek out. As a millennial, my generation is learning this for the first time. Don’t kid yourself for one second: they will destroy wealth.
This element of speculative risk was underlined by an article in The New York Times on July 8, 2020, Robinhood Has Lured Young Traders, Sometimes With Devastating Results. The author, Nathaniel Popper, writes about Richard Dobatse, a husband and father, who signed up for Robinhood through credit card advances. As he repeatedly lost money, Mr. Dobatse took out two $30,000 HELOCs to get more money involved with the trading platform with more speculative stocks and options, hoping to pay off his debts. His account value shot above $1 million in value, but as of the article, his balance was $6,956.
To digest this for Smead Capital Management clients and investors, we call this stock market failure. Many investors never find an investment discipline that provides them long-term stock ownership. What Mr. Dobatse experienced is not uncommon. Investors who share these experiences look at the stock market for years after this type of failure as a place that is big, frustrating and very confusing. Most investors can empathize with these emotions.
The other way investors experience stock market failure is by just being human. This causes them to feel excited at high points and depressed at low points in overall stock prices. Mr. Market is good at this. As Dalbar and many studies have shown over the years, most investors never attain the returns they seek in stocks.
As an example of Dalbar’s work, the investors in the crash of 1987 did far worse than they should have:
In October 1987, the average investor lost 20% of their account value. Although buy and hold would have yielded a gain for the year, there was a net withdrawal of funds in 10 out of 12 months. And the investors stayed out of the market for the most part until March 1990.
The investors produced stock market failure in their activity within the stock market. They poured far more money in at the top and pulled it out at low points. Baby boomers poured money in like you couldn’t believe in 1999!
Investors are not born to buy into bubbles; their recent experiences lead them to see future gains as being irrationally more probable because those are the memories most available to the average investor’s brain,” according to the study. “Leading into the dot-com bubble of 2000, the average investor was drawing on 5 years’ worth of memories in which the S&P saw 20% or greater growth!” In fact, investors contributed 20% more per month in the 24 months leading up to March 2000 than historical data shows they had done previously.
The reality is that this manic activity that produces stock market failure doesn’t just lower returns; it destroys wealth.
As Richard Bernstein, a former chief investment strategist at Merrill Lynch who now runs his own firm, told me, “What’s shocking is that simply by investing, most people actually made themselves poorer.” He added, “They’re just shooting themselves in the foot, over and over.
We belabor this point to advise investors where we are at in the pendulum of stock investing. We believe there is a euphoria present in markets, not unlike 1999 or particularly 1972. Jeremy Grantham of GMO highlighted where we are in light of price to earnings ratios from a historical context today:
Everyone can see and feel that this is different and can sense the bizarre nature of the market response: we are in the top 10% of historical price earnings ratio for the S&P on prior earnings and simultaneously are in the worst 10% of economic situations, arguably even the worst 1%!