Dangerous Bull
The markets are still rallying as the S&P 500 has gained 75% from its lowest point during the initial coronavirus panic sell-off in March 2020. Fueled by speculation and government intervention, the rapid recovery has set off a chain reaction in creating new interest for investing.
The market’s impressive gains have enticed people from all walks of life to become part-time stock traders. Commission-free trading platforms with gamified online interfaces have made it easier than ever for anybody to enter the market. Robinhood, one such platform, gained 3.1 million users, half of them first-time investors, in the first quarter of 2020.
“It does seem that the pandemic might have led to increased adoption of online platforms,” said Northwestern economics professor Richard Walker. “The stereotype is that bored, young tech-savvy people sitting at home decided to download apps and play the market.”
These traders, dubbed ‘retail’ investors, proved their might during the meme stock surge during January 2021. Their influence led to surges in stocks such as Gamestop and AMC as part of an orchestrated effort to execute a short squeeze aimed at Melvin Capital, a hedge fund run by Northwestern alum Gabe Plotkin.
“There has never been a better time in the market’s history to be a retail investor,” said Jim Toes, President and CEO of the Security Traders Association. “Advancements in technology have afforded retail investors unprecedented access to research, market data, investment products and low transaction costs.”
Northwestern first-year Adam Ruzumna saw success during the Gamestop saga. He turned a $50 investment made in February 2020 into a $1,450 return when the company skyrocketed 11 months later. Ruzumna understands that this success is an anomaly and is worried about the perception of the stock market as a vehicle for easy money.
“It’s dangerous when people get into the market simply because they think they can replicate that level of success,” Ruzumna said.
On the surface, an influx of new investors appears to be a net positive for society. More people are learning how markets function, and the disparity of information between the wall street professionals and average people seems to be shrinking. However, the events of the last several months have laid the groundwork for a potentially poisonous combination: an overvalued market and amateur overconfidence.
Most stock prices are higher now than they were pre-pandemic, despite companies reporting lower earnings than in fiscal 2019. According to the Motley Fool, the average stock in the S&P 500 currently has a price-to-earnings (P/E) ratio of 34, the highest it’s been since the Great Recession. While most hope for the pandemic to be a chapter in the past, its broad-based effects will likely linger for years to come.
“Valuations are high for the market overall across a number of traditional metrics,” Toes said. “There is always risk of a correction.”
Wall Street doesn’t fear a market downturn anytime soon. A survey of firms projects a nine percent increase in the S&P 500 in 2021. This increase in pools of funds, combined with government stimulus and the Federal Reserve’s commitment to positioning the market for recovery, will likely lead to artificial inflation of company valuations.
Despite high stock valuations as reflected in traditional market metrics, the market rally has captivated an entirely new generation of traders who look at the market as their ticket to free money.
“It’s always disconcerting when you hear about young investors who don’t seem to understand the basic concepts of investing and think the stock market is like a casino,” Toes said. “There is no free money.”
Although risk is present, Toes believe that the benefits of new market entrants greatly outweigh the costs.
“Investing in the equity markets is good for the American economy and, most importantly, can be an important part of a person’s overall financial success,” Toes said.
Walker adds that the most important habit young people must build is not necessarily their investment algorithm, but how much they choose to save rather than consume.
“Even low yields compound over time, so start saving as early as you can,” Walker said.
Ruzumna agrees, adding that a greater understanding of markets, combined with a more democratized approach to investing, will lend to optimal societal results — even if some expensive lessons need to be learned along the way.
“Young investors can afford to take on more risk,” Ruzumna said. “Maybe they lose money at first, but then they’ll develop investing principles they can use for the rest of their lives.”
