Parallels abound between the frothy run up in stocks since April 2020 and the late 1990s dotcom boom. Consider the 600% gain in the shares of Tesla Inc., the GameStop Corp. short-squeeze played out with options on the “free” trading app Robinhood that drove the stock from less than $10 to almost $500, or the sudden surge in the shares of mortgage firm Rocket Cos. And, of course, the ongoing phenomenon that is Bitcoin, soaring from around $10,000 to more than $57,000 in a matter of months.
While similarities are seemingly everywhere, there are also significant differences. Knowing and understanding those differences will provide insight as to whether the current episode ends with a bang like in the first quarter of 2000, when the Nasdaq 100 Index peaked late that March before embarking on an 81.9% tumble that lasted until October 2002, or a whimper like in the fourth quarter of 2018, when the benchmark suffered a 22.8% drop between early October and late December only to be followed by a robust rebound right up until the Covid-19 pandemic took hold in February 2020.
Here is a list of five meaningful differences between the two eras:
1. Information sources: What investors base their decisions on has changed over the past 20 years. Some 57% of them rely on professional advice today versus 49% in 2001. The shift toward more professional advice is part of a larger migration away from traditional sell-side Wall Street brokerages and toward fiduciary advisory firms. (The largest brokerage firms are hybrids, with both brokers and advisors, and have seen their businesses lines shift toward fee based over the past decade.) My suspicion is that much of that accelerated in the 2010s, post-financial crisis.
Even more significant are the info sources relied upon by investors: A study by the Brunswick Group identified blogs as the most important information source for making an investment decision at 70%, up from 38% two decades ago. (Search engines are the most frequently cited research tool, but are—obviously—used to identify other original sources.) Podcasts, once a source for 29% of investors, has risen to 46%. These large gains have come at the expense of mainstream media and advertising sources.
How do changing information sources alter investor decision making? In a variety of ways, many of which pose substantial risks for investors’ portfolios.
2. Social media / Speed of transmission: The most stunning shift is in how fast news moves today. Breaking stock ideas, rumors and commentary are disseminated not just via Twitter, but other platforms such as Reddit, LinkedIn, Facebook, Instagram, YouTube and TikTok as well. It takes but a second to cut and paste 280 characters and even less to retweet an item.
This is the sort of thing that efficient-market aficionados tout as they explain why prices reflect all known information instantly. All available information eventually finds its way into market prices. There is even a new exchange-traded fund with the ticker symbol “BUZZ” focused on Twitter and Reddit “meme stocks” that attempts to take advantage of the flow of information on social media. The strategy looks like a brilliant update on the traditional promotion of stocks by Wall Street analysts, but at a much faster speed.
The “need for speed” risks pushing investors toward rapid and often excessive trading. The academic research overwhelming shows that for the majority of investors, this leads to worse investing performance, higher costs and increased capital gains taxes that erode returns.
3. Fake news and disinformation: The obvious risk in all of that misinformation, rumor and hype are more and faster mistakes. A 2018 study titled Fake News in Financial Markets used a “novel dataset” from an undercover Securities and Exchange Commission investigation and found that “fake articles directly induce abnormal trading activity and increase price volatility” with the results “particularly acute among small firms with high retail ownership and for the most circulated articles.”
Sinan Aral, who runs Massachusetts Institute of Technology’s Initiative on the Digital Economy, explains in his new book “The Hype Machine” that this social media crisis is the inevitable result of iterative algorithms. While regulation is necessary, Aral adds that we need to put pressure on platforms to take greater responsibility for “maintaining the quality of information within their own environments.”