By Steve Sosnick, Chief Strategist at Interactive Brokers
America Online, or AOL, was one of the true darlings of the early internet. I’m old enough to remember buying a PC and having the salesman use the complimentary AOL disc as a selling point because AOL was considered “cooler” than the already stodgy Prodigy or Compuserve alternatives. AOL rode the late ‘90s internet stock rocket to enormous heights, culminating in its now infamous merger with Time Warner 20 years ago this month.
My point in referencing AOL is not solely to remind readers that the stock went from roughly $200 to about $40 within two years of that deal. Because of AOL’s dominance, it was also the primary source for stock market chatter during the go-go market. As we’ve written previously, the advent of internet brokers led to a huge democratization of the stock market. It gave unprecedented, low-cost access to markets for a wide range of investors, and millions took advantage of that access.
The internet also revolutionized communications between investors. Rather than communicating ideas – and rumors – via phone calls, speculators could utilize chatrooms to communicate directly amongst themselves. One of the primary sources for market chatter was AOL, which had become the dominant internet provider for the masses.
Is that much different than what we are seeing today? Reddit may have surpassed AOL as the predominant source of market chatter for individual investors and other speculators, but the game is the same. Buy a stock (and/or its call options), talk it up in a forum, get people to follow and ride the new demand for a quick profit. This is a game as old as markets themselves, though the mechanism for playing it changes and its popularity ebbs and flows. This is a particularly fertile time for speculative pumps. As in 1999 there was a huge democratization of the markets – this time with free commissions and fractional shares – at a time when the Federal Reserve was actively raising its balance sheet. History doesn’t repeat, but it often rhymes.
I was speaking with an old friend who is an experienced fund manager with an enviable track record earlier today. (We spoke on the phone, quaintly.) The subject of Gamestop (GME) came up, as it does in so many market conversations. I won’t belabor his comments about how overvalued the stock was, even before the recent mania, but instead focus on his anecdote from 1999.
He recalled seeing thin-film resistor stocks that traded on the pink sheets rise from 50 cents to $25 in the course of a few days. He knew at the time that it was frothy, but realized that the end was near when the source of his tip on that sector came from a Vegas blackjack dealer. Another rhyme. It wasn’t Bernard Baruch’s shoeshine boy, but close enough.
Don’t get me wrong. I never begrudge anyone making money legally, nor would I ever discourage any individual from investing responsibly, or disparage his or her lack of expertise. I consider my most important function to be imparting some of my expertise to investors who seek it. But what we’re seeing now is historically unsustainable and has an unsavory resemblance to illegal pump and dump schemes. For those reasons, I can’t advocate jumping into the most manic situations.
Greater Fool Theory
A key concept for investors to understand is the “greater fool theory.” If you purchase any investment you should have some rationale for doing so. It could be fundamental, technical, news-related or even momentum. But momentum is a fickle friend. If your only reason for making an investment is solely that you think someone will pay more just because it is going up, you are betting that there is a greater fool than you. Poker players know that if you can’t figure out who is the sucker at the table, it probably is you. If you are blindly following chatroom advice and market momentum, you might be that sucker.
This article, first published on Jan. 25, appeared on Traders’ Insight
Photo Credit: Martin Thomas via Flickr Creative Commons
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