It pays to keep a cool head when markets lose their minds
This is a dizzying time to be an investor, as markets fly to record highs and bubbles pop up in the strangest of places.
All sorts of assets have rocketed to the moon, from crypto-currencies to micro-cap stocks, while investors on social media forums such as Reddit’s WallStreetBrokers have triggered a buying frenzy for ailing US video games retailer GameStop.
We live in unprecedented times, but investors need to stay calm and avoid getting swept up in all the froth and hype.
You can make big money at times like these, or lose a small fortune.
So what’s happening and how do you respond?
Up, up, up
Everywhere you look, asset classes are smashing records.
Bitcoin surged to a record high of $41,962 in mid-January, before falling back, while fellow Dogecoin has been even crazier. This joke cryptocurrency based on an internet dog meme rose 800% in days, then just as quickly lost its bark.
The craziness isn’t confined to cryptos.
Margin trading is at a record high, with more people than ever borrowing money against their portfolios to fund stock purchases. In December, US traders borrowed a record $778 billion, figures from FINRA show.
Smaller companies are also flying. The Russell 2000 Index of smaller US companies jumped 31.4 per cent in the final three months of 2020, its best ever quarter.
Meanwhile the US tech titans power on, with trillion-dollar companies Apple, Amazon, Microsoft and Google-owner Alphabet driving the S&P 500 to a record high of 3,855 in late January. It is up an incredible 66 per cent since last March.
Electric car maker Tesla climbed around 800% last year, making founder Elon Musk the world’s richest man, while hedge funds that best against it lost a cool $36 billion.
These are crazy times, which brings us to GameStop.
Seen it, bought it, Reddit
Until recently, few investors had heard of GameStop, and even fewer wanted to buy it. It looked like yet another bricks and mortar retailer crushed by e-commerce, selling video games on disks when most gamers prefer downloads.
Big hedge funds started shorting the stock hoping to profit from its decline, but then day traders on Reddit and other social media platforms fought back, driving its price from $4 to more than $400 and triggering a massive short squeeze.
Fortunes have been made – and lost. Hedge fund Melvin Capital is said to be down by around $7 billion.
To some, this is a David-and-Goliath moment, as the little man takes down Wall Street giants that have manipulated markets for years.
To others, it’s the moment the market went mad. An example of the late-stage mania that afflicts stock markets in the dying days of a long bull run.
It echoes the 1990s tech boom, where start-ups that had never made a cent were suddenly trading for billions, and private investors were borrowing money to buy them.
You know what happened next.
Money, money, money
So why has everybody gone crazy? Naturally, the pandemic is playing a part. Many Reddit traders were locked down at home with no sporting events to bet on, and worried about their jobs and futures.
All of last year’s fiscal and monetary stimulus is flooding into markets, and we still have President Joe Biden's $1.9 trillion emergency package to come.
Vaccine success is also lifting sentiment, as they promise a way out of today's strict lockdowns, provided they can beat Covid-19 mutations.
Many believe that when the consumers are finally released from lockdown they will go on a spending spree, creating a flash recovery.
Some fear it will all end in tears instead. Stock market historian Jeremy Grantham reckons the post-2009 bull market has now matured into a “fully-fledged epic bubble”. This could be “one of the great bubbles of financial history, right along with the South Sea bubble, 1929, and 2000”, he says.
So should we be worried? The first thing to remember is that nobody can predict stock market movements with any consistency, no matter how clever they are. There are just too many variables to take into account. As Mr Grantham admits himself: “Nothing is certain.” Stock market crashes are only clear in retrospect. If you pulled your money out of the market every time somebody called a crash, you would never invest and end up a lot poorer as a result.
So what should you do?
Keep calm, carry on
The most important thing to remember is that investing is a long-term game. When building wealth for retirement, you are investing for 30 or 40 years.
Over such a lengthy period you will see plenty of stock market crashes, and your best response is to grit your teeth and stay invested.
Anybody who sold shares in the Covid crash last March will still be kicking themselves, as markets rebounded faster than expected.
You simply cannot time markets in this way.
What you can do is take advantage of a dip in share prices, to go shopping for your favourite assets at bargain valuations.
Don’t seek perfection when the crash comes, and hope to find the absolute bottom of the market. That's as hard as predicting the top.
Just do your best.
If you buy shares and markets fall again, buy more.
It’s a wild world
As for GameStop, and other “wild-story” stocks, such as AMC and Blackberry, approach with extreme caution.
I’ve spent an unhealthy amount of time on chat forums lately, following traders as GameStop stock shoots up and crashes down.
They aren’t investing, they’re gambling.
I don't want to spend my life staring at a screen, obsessing over the movements of an asset I do not understand.
If you feel differently, that's fine. Just remember, in this strange new world old rules still apply. Never gamble money you cannot afford to lose.
Harvey Jones has been a UK financial journalist for more than 30 years, writing regularly for a host of UK titles including The Times, Sunday Times, The Independent and Financial Times. He is currently the personal finance editor of the Daily Express and Sunday Express, and writes regularly for The Observer and Guardian Unlimited, Motley Fool and Reader’s Digest.
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