Economics, Advanced Technology, and Social Media

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Fundamental drivers for pricing valuations in public markets have changed. Now, there is a new interaction among factors unseen just recently. Advanced technologies such as artificial intelligence have had a profound impact on the tools available and analysis presented to even the most amateurish investor. Social media, such as Reddit, Twitter, and other platforms, have allowed access to information and influence from media “stars” driving demand in an almost herd-like mentality driving up prices, and causing extreme volatility. Finally, technology has enabled a trading floor to be in everyone’s pocket. That same trading floor allows access to any information on anything from anywhere, and communication with anyone or, via social media, receive communication and information (regardless of how dubious) from anyone about any security or investment strategy.

These factors will cause unprecedented market volatility, along with extreme price movements for well-known (or perhaps more accurately, well-publicized) companies and their securities. While the supply of securities remains somewhat constant, demand for those securities is increasing (sometimes exponentially) because many more investors are now chasing those same securities.

The price of anything cannot escape supply and demand dynamics. Recent IPO activity is an attempt to meet growing demand (and raise capital at attractive prices). The new supply from IPO’s, secondary stock issuances, and most recently and monumentally, SPAC offerings, still do not provide enough supply to quench a growing and overwhelming demand. The valuations, especially those given to the SPAC’s, are entering stratospheric levels that could hardly be justified under normal market conditions. Successful investors are the ones who understand adding return without corresponding risk is the most critical component of successful investing, especially given the new equation for valuation:

Economics + Advanced Technologies + Social Media = Price

These three components are now inexorably linked and constitute an influential role in determining valuation from now on.

The More Things Change…

The pandemic has challenged many preconceived notions about the economy, markets, and public policy – and has impacted the way we live. But the inescapable truth remains unchanged:

There is no magic answer. No solution other than superior skill enables an investor to earn a high return safely and dependably. That is even more true in today’s low-interest rate, low return Tower of Babel world.

Uncertainty and prediction

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The world economy is an infinitely complicated web of interconnections. We each experience a series of direct economic interrelationships: the stores we buy from, the employer that pays us our salary, the bank that gives us a home loan, etc. But once we are two or three levels degrees separated, it’s impossible to really know with any confidence how the connections are working. That, in turn, shows what is unnerving about the economic calamity potentially accompanying the coronavirus.

In the years ahead we will learn what happens when that web is torn apart when millions of those links are destroyed all at once. It opens the possibility of a global economy quite different from the one that has prevailed in recent decades. Or, as John Kenneth Galbraith has said, “we have two classes of forecasters: those who don’t know and those who don’t know they don’t know. “The bottom line is establishing and maintaining an unconventional investment profile requires acceptance of uncomfortably idiosyncratic portfolios, which frequently appear imprudent in the eyes of conventional wisdom. We are entering a new world and must think differently.

Things Have Changed – Sort of

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The last few weeks highlighted the need to bring a new understanding of, and strategy for, investment risk. Volatility is increasing and occurring over a significantly compressed timeframe – for individual stocks and the overall market. Recent trading activity in GameStop, AMC, and a few other stocks demand an investment strategy focusing on Risk Adjusted Return. The new power of retail investors is here to stay, and that will shake up traditional portfolio managers because they are increasingly losing control of the trading process. Trading apps on platforms like Robinhood and social media chat rooms found on Reddit are game changers, fueling an unprecedented level of interest and activity (social media information is easily accessible and trading activity has very little friction – few, if any fees, and immediate). These two factors are irreversibly changing the market. In the past year, U.S. brokers added at least 10 million new retail trading accounts, and a shift to zero trading commissions late in 2019 unlocked a wave of activity that dwarfed even the wild days of the dot-com bubble. Beginning in early 2020, and coinciding with coronavirus lockdowns, trading activity started to surge and has not subsided, even as the economy has gradually reopened. Average daily trading at the biggest retail brokers hit a record of 6.6 million a day in December 2020. In January 2021, it reached 8.1 million. On January 27, 2021, equity volume was triple the average day in 2019.Retail investing has been a small fish trading in the large hedge fund and institutional pond. But that’s changing. Before the pandemic, retail trading made up about 15% of equity volume; now, it’s consistently making up more than 20%. The game changer is when that activity is concentrated on just a few stocks, a much more likely event among retail investors (driven by social media platforms), and it makes a substantial difference. In the case of GameStop and several other highly shorted stocks, it can cause startling price movements in a very short time.