Mind on Money: Market drama could be warning sign

Mind on Money: Market drama could be warning sign

It was the Friday before Martin Luther King Day in the year 2000. I was 29 years old and at the airport with six buddies, waiting for a mid-morning flight, on the way to a guys' ski trip in Jackson Hole, Wyoming. Anyone who has ever been on a guys' ski, golf or fishing trip knows the mood of the group is usually quite jovial.

We arrived at the airport early and had time for a Bloody Mary in the airport bar, where we could all reconnect and talk about the only topic anyone wanted to talk about at the time: stock trading.

Online trading was still fairly new, laptops were rare, and smart phones weren’t even conceived of yet. But I had an office with partners who could help put in trades, and some of the group had put in orders the night before on their online accounts. Everyone in the group was trading in one way or another.

Everyone was an expert, and a trading hero, of course. Having helped manage other people’s money for six years already at the time, I was actually the most conservative of the group. They teased me about my conventional approach. The high-flying market at the time was showing us a new normal, according to my companions.

We got on the plane around 9:00 for the three-and-a-half-hour flight. We landed just after noon, got our skis off the baggage claim and ran to check our stocks. In the four hours or so while we were in transit on the plane, every single one of us had become $5,000 to $10,000 richer. Our more seasoned investors would recognize with a smile some of the stocks that were making these crazy gains. It was glorious, we were geniuses, we were kings. We had a great weekend.

In exactly seven weeks it was all over, as the dot.com bubble burst, destroying a whole generation of online trading accounts. Some of the brilliant traders on the Jackson Hole trip actually ended up owing their brokerage firms money as stocks collapsed and margin calls required them to deposit money to their accounts. A couple of these young guys wouldn’t touch the stock market again for decades.

This week, a drama I’ve never even conceived of played out in the stock market. The source of the drama was a handful of stocks being obsessively followed by small (assuming young) retail investors on online message boards. These message boards, which I have looked at, are chocked full of insanity, humor, misleading information and brilliant analysis, all at the same time. Some of the blog posts are sophisticated and technical, some are simply full of rocket ship emojis. It is truly a sign of the times.

These online message boarders are engineering what is called short squeezes on stocks that have high short interest. When investors short a stock they are in effect borrowing shares to sell them, hoping to purchase the shares back at a lower price to repay the stock to the lender. It’s a speculative trade hoping to benefit on stocks that go down.

These types of short trades are most often utilized by professional investors, and by hedge funds in particular. These message boards have created buying frenzies in stocks with a high level of shorted shares, or short interest. As the buying frenzy drives share prices higher, the short seller is squeezed by margin calls and the result has been a number of questionable stocks going up 1,000s of percent in just days, with the mania surrounding these crazy moves creating even more trading insanity.

In a way this process has been glorious to follow. Small scrappy investors, sharing their own analysis, brutally punishing hedge funds betting against weak companies. Because I think even hedge fund managers hate hedge funds, it’s a classic David and Goliath storyline. It’s also highly irregular and I think a sign of something larger. I believe the froth in this market has now become undeniable.

Mark Twain famously said, “history may not repeat itself, but it sure does rhyme.” At some point, this generation of traders may have to learn the same lessons as my ski buddies did. The primary one being, no tree ever grows to the sky.

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. Stock investing includes risks, including fluctuating prices and loss of principal. Marc Ruiz is a wealth advisor and partner with Oak Partners and registered representative of LPL Financial. Contact Marc at marc.ruiz@oakpartners.com. Securities offered through LPL Financial, member FINRA/SIPC.