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12th February 2021
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Graham BentleyGraham BentleyInvestment commentary - February 2021 by Graham Bentley

A monthly investment commentary by definition recounts very recent events, whose effects are frankly often transient. However, some market events can become major cautionary tales.  Investment success, (much like golf in my experience) is often linked to the avoidance of errors rather than the accumulation of 'winners'. Consequently, this month please allow me to muse on a phenomenon that arose during January (thus satisfying the commentary definition) that I believe is a powerful confirmation of that idea.

First, a little context. A long time ago stock markets were inhabited by direct, individual shareholders. Investors had little access to information, trade or settlement was pedestrian, and transaction fees and brokerage commissions were barriers to profiting from 'speculation' for all but the wealthiest traders. The average investor held on to their shares for more than eight years, or at least as long as dividend payments arrived. 

By the early 1960s, “people's capitalism” was a term popularized by the New York Stock Exchange to declare widespread participation of the general public in the ownership of American industry. This idea of a shareholders' democracy conveyed an image of economic correspondence, the small investor and the wealthy, the man and woman in the street marching arm-in-arm with the CEOs and directors of corporations. Sadly, a large number of shareholders has never represented an equal sharing of industrial ownership. We are used to one-man-one-vote in a democracy, but in markets owning a million shares gets you a million votes. 

Today, investors generally use a fund manager who pools individuals' investments into portfolios where the fund manager votes on their behalf. In the US, direct share ownership is much more prevalent than the UK. The internet allows torrents of information to be shared instantly, while shares can be bought commission-free and sold instantly via mobile apps. This allows many to bet relatively small amounts of money on the low-probability of very short-term excessive share price movements. The average holding period of a share is now less than 9 months, due to the impact of amateur investors 'day-trading'.

Social media have become platforms for idea sharing, providing rallying points for factions sympathetic to those ideas. Once transmitted via the internet, these ideas or 'memes' can spread like a virus. Individual investors, in isolation and versus the might of institutional mutual and pension fund managers, might never be expected to influence share prices directly on a one-share-one-vote basis. Unless of course thousands of those small shareholders were 'memed' into to acting in unison. 

As well as finding good companies, investment managers spot poor companies too. Rather than avoiding those, fund managers can bet on a company's share price falling, by borrowing shares from a willing lender in exchange for a fee, and selling them at the current price. They expect to use that money sometime later to buy those shares back at (say) half the price they sold them for, returning them to the lender and pocketing the difference.

While that's a risky strategy, i.e. if the share price rises you lose money, some companies can appear to be a one-way bet. For example, GameStop: a chain of stores where you have to travel to buy a video game in a box rather than streaming it (that's why there are no more video shops - remember those?). Or AMC, a cinema chain without a paying audience in a pandemic. While conventional fund managers may use these tactics sparingly, hedge funds attempt to make money in all market conditions and hence need to profit in down-markets.  This 'short selling' approach - benefiting from a company's despair if you will - is seen by some (erroneously I might add, but that's for another day) as a villainous activity.

Members of online community WallStreetBets have been leading a swarm of amateur 'vigilante' traders buying stocks that hedge funds were betting against, in order to force prices up so that the hedge managers lost money. This saw the price of GameStop amongst others rise by almost 1800%, tempting thousands of other less sanctimonious individuals to join in and ride the rocketing price as the hedge funds had to buy back shares to try to cut soaring losses, further accelerating price rises. Many used an app that allowed complete amateurs to buy particularly risky derivative contracts that could multiply their potential gains (or losses, as we shall see) by many times. This became known as YOLOing - betting 'your entire life savings' - and even has its own hashtag allowing newbies to copy the host of people posting their life-savings-and-all trades.

The media suggested that this was a major moment in the history of stock markets; had people's capitalism finally arrived, a new dawn of shareholder democracy?

I didn't witness the 17th century Tulip mania or the South Sea Bubble of 1720, but I'm old enough to spot the madness of crowds. A week may be a long time in politics but it's the blink of an eye in economic history and predictably perhaps, a painful reckoning has begun.  Thousands of investors who had leapt on the bandwagon have seen bruising losses as prices reverted to common sense levels, falling 60% in a day. One internet 'celebrity' admits to having lost $700,000 dollars, while many have wasted college funds and more unsuccessfully trying to recoup losses.

January has demonstrated yet again that in investment terms at least, avoiding errors and sticking with a plan will generally outperform constant attempts to hit a sensational winner.

I will try to remember this if ever we're allowed on the golf course again...


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