If you want to play a game, take off an item of clothing every time I allude to the unprecedented times in which we live. As Justin Timberlake once proclaimed, "I'll have you naked by the end of this song".
Question: Were finance and economics ever more interesting than it is right now? I dare say we are in unprecedented times. For one, stock prices have never been more expensive in the history of public exchanges. Microsoft (NASDAQ: MSFT) is about to join the two trillion-dollar club, Tesla's (NASDAQ: TSLA) valuation is supercharged, and the NASDAQ and S&P 500 are at unprecedented record levels. Put another way, at no time in history has the valuation of some publicly listed companies been so far removed from their traditionally gauged intrinsic value.
Well…, there have a couple of times where the PE ratio of the S&P was higher than it is now. That is, immediately following the 2001 Dotcom crash and 2008 GFC.
But since our current bubble hasn’t popped yet (the only way we know we are in a bubble), let me speculate under the assumption that this is the new normal, and these are in fact, unprecedented times.
I do not think investor optimism is the reason for these valuations, more so desperation. We all know that Central Banks' unprecedented spending has led to an inflation in asset prices; governmental desperation, if you will.
But perhaps everyone is also a little desperate to not miss out on the next decade's big growth stock like they did last decade. If you had invested US$10K into Netflix (NASDAQ: NFLX) on Jan 1st, 2010, that little nest egg would now be worth over US$704K (I suggest you check out stockchoker.com to retroactively FOMO over other missed investment opportunities).
This asset inflation is excellent news for those who have KiwiSaver, AustralianSuper, 401Ks, and the like. Personally, my KiwiSaver has grown at an alarming rate since the infamous pandemic emerged. But I will not be able to touch it for another 40 years; who knows what will happen in this time? I presume a long list of unprecedented events.
I do not expect the growth we have seen recently to be the new normal. But perhaps things will now tapper off, and companies' exceedingly generous valuations will be the new normal moving forward. This could be the new lay of the land and we will have to get used to hyper bullish valuations. For the sake of my KiwiSaver, I kind of hope so.
In the early 1600s, Tulips first arrived on the shores of Holland from Turkey. The flower was exotic, beautiful, and nothing like any other flower that grew in Holland at the time.
Like Turmeric was to the UK before exploring India, Tulips became an extremely exclusive and highly luxurious status symbol. It was stated that "it was deemed a proof of bad taste in any man of fortune to be without a collection of tulips." Tulips became a thing to have to "keep up with the Joneses" at the time. Therefore the middle class started to collect tulips to portray this image of wealth.
This demand and love for tulips inflated the cost of tulips bulbs, with the rarest tulip bulbs in the year 1636 going for $750,000 in today's money. However, many Tulips ranged from $50,000 - $100,000. At this point, Mania ensured. Individuals who held extremely rare Tulip Bulbs saw their assets increase in value just by having it. People believe the stock price could never go down and that "the passion for tulips would last forever."
Individuals started buying tulips on leverage and began to use derivatives in hopes that they would profit from borrowed money. However, as confidence started to waver, Tulip owners started offloading as fast as possible. This meant people with derivatives were selling at a lower price they bought it at, desperately trying to offload so they could pay their creditors. By 1638, Tulip Bulb prices returned back to normal.
Does this sound like a familiar story? GameStop, an American video game retailer, traded below $6 for most of 2020. It currently sits at $347. Is this the Tulip Mania all over again? Not quite.
The context of how we came about to a company that had a short float of over 80%, reversing to generating 1,800% in 30 days, is a convoluted one. Long story short, a Reddit community of retail traders on the subreddit called WallStreetBets thought of a simple but genius way of pumping up the price on stocks relatively cheaply: Induce a short squeeze.
With over 80% of Gamestop's stock short, the WallStreetbets community decided to purchase near-dated call options to induce a short squeeze while continuing to buy more call options, pushing the price higher and higher. This is akin to what Jordan Belford did in the Wolf of Wall Street and deceiving investors. However, the difference is that this time, not one person can be put to blame. Plus, its not illegal to speculate. It's like a social pumping and dumping scheme using options – without the dumping. The question arises, why?
I believe I am young enough to understand why this is happening and understand why older, more seasoned institutional investors don't. The reasoning also shows why it's quite different from Tulip Mania.
The unique concoction of cheap access to the equity and derivative markets, combined with lockdowns & stimulus checks and the rise of social media boards such as Reddit, has fueled young, money hungry, and humored retailed traders to enter into these risky trades because it's merely funny. No fundamental analysis is involved, just fun.
That's the difference between the Tulip Mania and Gamestop Mania – Tulip investors were doing it for the prestige, with the benefit of wealth. However, with Gamestop? The Redditors are doing it because it's humorous – it's funny to them buying a near-broke stock and pumping it up, even if they lose all their money. It is almost like the capital they inject into the market is the cost of entertainment.
There is no doubt a lot of the retail traders investing in Gamestop will lose money. However, that's the fun of it.
My brother was caught in the GameStop Mania – I woke up early for work this morning and saw him wide awake on his trading account buying these heavily shorted stocks "at times where me and my friend thought it was the funniest."
Will we see more of this in the future? Probably. Will people continue to lose money? Most likely. Will some people make a lot of money? Of course. Is this the financial world we live in? Yeah, it is.
I believe that investing should be accessible to everyone and anyone willing to put their money to work. Many people share this idea. That's why low-cost brokerage started to become popular. However, the bi-product of this is that phenomena like this eventually occur when retail traders throw away any fundamental analysis and game the system that large and rich institutions help create. This phenomenon is the antithesis of "Markets can stay irrational longer than you can stay liquid," however, this time, the market is a bunch of retail traders, and the "you" are the large, fundamentally drive hedge funds that are short.
With that said, Fundamental analysis will slowly come back into play. The Markets will gradually become rational again – the retail traders' confidence will waver, and derivatives will slowly come due. Prices will once again come crashing down as they did with Tulips in 1638. That's where the comparisons continue with the Tulip mania and this GameStop mania.
However, Tulips were only one exotic flower that the citizens of Holland could get their hands on.
There are many stocks out there. The question isn't when is GameStop going to crash – the question is, What stock is next?