We’re in a massive market bubble. When it pops a lot of investors will get wiped out

Originally published in The Toronto Star on October 12, 2021 as contributing columnist 

“Stock market bubbles don’t grow out of thin air. They have a solid basis in reality, but reality as distorted by a misconception.” — George Soros

Here I go again, sounding like a broken record. A couple months ago, I wrote an article noting that we are likely in the final act of the biggest stock market bubble in history. But given there is so much at stake, I feel an obligation to repeat myself. In doing so, I know I will draw the ire of many market participants. It’s a given that Chicken Littles are never very popular when everyone is having a good time.

But the fact remains that this bubble, like every bubble that preceded it, will end eventually. And when it does, lot of investors are going to get wiped out. Sadly, the majority of those losers won’t be the “inside” crowd. Instead, they will mostly be average, unsophisticated investors. But rather than rehash my opinions on the state of the markets, I would like to focus on the psychology of the class of investor that is the latest entrant to this 12-year-long U.S. equity bull market.

It’s fair to say that most individual market players today don’t abide by the Warren Buffett rules to investing — the type of mindset a sensible investor should cultivate when making financial decisions: “Don’t be frivolous by failing to do homework, don’t gamble and, above all else, never go into financial decisions thinking it is OK to lose money.” In fact, it appears that it’s the exact opposite.

Rather, we live in a new world where more than 20 million new, and presumably novice, investors using the Robinhood app share tips, information and other nonsense on massive online communities like Twitter, Reddit’s Wall Street Bets forum, Discord, StockTwits and yes, even TikTok.

It’s in this alternate universe where a freewheeling crowd of spectators manufacture, sell and drink their own Kool-Aid. One could spend hours being entertained by reading some of the crazy advice and theories that are served up in these chat rooms — advice like “quit your day job” and “only work two hours a day trading the markets.”

I learned a long time ago that day trading is a losing game. Ninety per cent of day traders end up losing money. It’s a bit like gambling — you are playing against the house. The odds are against you.

I saw one YouTube video recently that made my eyes roll: a guaranteed-momentum day-trading strategy presented by some kid barely out of high school. The sage advice being offered? “Buy at the bottom and sell at the top” — using charts, of course, and all presented with an air of gravitas befitting a Nobel laureate in physics. Or “put all your savings into crypto because everything else is shite.” Everyone is selling a guaranteed ticket to riches. 

These new players have different rationales for being in the markets.

Meme stocks are run up for the sole purpose of “sticking it” to the Wall Street establishment short players. The theory being, “Let’s buy the most hated stocks and squeeze the short-sellers.” Then, they sit back and pray they get out and are not left holding the bag when the shares fall again. Not exactly rational thinking, but that’s a characteristic that is increasingly hard to find in these forums.

Some investor apps are actually designed with dopamine-inducing features, much like a casino slot machine. And to ratchet up the risk even further, more and more, investors are turning to leverage, using margin and options in order to turbocharge their gains. What is causing all this madness?

Greed is an obvious motivator, but jealousy also plays a role. As bubbles mature, they draw in more and more new players. There is nothing worse than knowing your neighbour just made a killing on some meme stock or cryptocurrency. The FOMO is unbearable and no one wants to be the only loser to miss out on the action.

There is also a growing notion that there is no other way to get ahead in a world that is increasingly favouring the rich at the expense of the rest of society. Incomes for the average worker have stagnated for decades and COVID only made things worse. Participating in a rising stock market is seen as the only way to stay above water.

The theme “cash is trash” is also gaining popularity. There is a genuine fear that central bank money printing is making cash worthless. Cryptocurrencies have been the greatest beneficiary of that theme. And then there is the NFT (nonfungible tokens) craze. The crypto and NFT worlds are completely unregulated; price manipulations and pump-and-dump schemes are rampant and there are no rules in place to protect investors from their own stupidity. When this bubble finally bursts, these novelties feel like the most likely to get hammered: In one recent NFT offering, individual flatulence recordings are available for 0.05 Ethereum, or about $85 a pop.

The bottom line: for this Reddit crowd, the markets are seen as the only financial refuge. But as the Eagles song says, “Every form of refuge has its price.”

We live in a world where the blind are leading the blind and the madness of crowds reigns supreme. Where rock-star fund mangers such as Cathie Wood from Ark Invest make statements like “Millennials will power a bull market in stocks for decades,” which to me, is reminiscent of saying stock prices “have reached what looks like a permanently high plateau,” as Irving Fischer did in 1929 one month before the infamous crash. I have found that there is a Cathie Wood at the peak of every market bubble. I prefer the wisdom of folks like the legendary Jeremy Grantham who recently said U.S. stocks are in a “magnificent bubble,” one crazier than 1929.

Although it’s impossible to determine how high these markets will get, the writing is flashing on the wall in neon red. As a friend of mine who is a very astute market watcher said to me recently, “when my mother-in-law, who is a nurse and has never invested in the markets, spends all her spare time on investor chat rooms, who is left to invest?” Hmmmm.