During the internet boom of the 1990s, a culture of day trading bloomed. The speculators tried to guess the direction of a given stock and pile into it if the direction was perceived as up. When the gains tapered off, the stock was dumped. By doing this several times a day, the day-trader could potentially earn high returns on his or her capital. They could also lose their shirts, as most of them did in the ensuing crash.
Unfortunately, the market became more volatile than the traders could get in front of. Trying to “buy the dip” became a suicide mission, as the market began to go not only up but down. As the internet stocks began to show their inability to match their growth prospects, prices went lower still. In the end, most day traders lost money, and more than a few got wiped out.
Fast forward to 2020. With so many people impaneled at home due to the coronavirus pandemic, and with the introduction of apps on smartphones like Robinhood that permits people to trade their accounts anywhere, a new generation of day trading has come back to the stock market at full force. As before, people are trading stocks and other securities based on their momentum. If a stock goes up, speculators pile into it. When the momentum shows signs of waning, the same parties look to bail, to go on to the next idea. This time around, not only are stocks and options being traded, but commodities and currencies are as well, mostly due to the existence of an Exchange-Traded Fund (ETF) unit, which permits investors to do so. Like the previous day trading boom, people are often speculating with their retirement accounts.
That this will end badly is a given. The question is how badly. The crash in oil in March, when the posted price briefly went negative, showed several shortcomings of the day trading strategy. For one, traders are not only competing with each other, but also with computer algorithms that sense the turn in prices faster than any individual trader. Such computers can see all the market trades in a security at a given time, and thus it has a perspective that no individual trader can match. Because brokerage firms get compensated for matching up trades or flowing the trades to someone who can, the computers see the orders before they are executed. This is equivalent to a gambler betting against the house when the house gets to see the cards before they are dealt.
Add to this the fact that many day traders are dealing in securities that they do not understand, such as put and call options. Some use leverage (borrowed funds) that can leave them with substantial liability if the trade does not work out. The image of children playing with matches immediately comes to mind.
Before thinking this is just a fringe activity, consider this: in 2010, just over 15 million option contracts were traded per day. So far, in 2020, the volume is 27.5 million. Trading in gold and silver is getting so voluminous that the ETFs are having a hard time finding enough physical metal to back the ETF units. Internet chat rooms talked up the stock of companies like Hertz and JC Penney to the point the stocks tripled, even after they declared bankruptcy and their pre-bankruptcy common shares were declared worthless. E-Trade opened as many accounts in June as all of 2019.
In Wall Street, there is a term for providing a supply of investments to such clients who ignorantly trade more on rumor and stories than on facts. It is called “feeding the ducks.” Investing takes time and research, and while assumptions have to be made, it is usually longer term. Speculation requires none of this, only a desire to get on something when everyone else does and get off before they do. In this sense, the name of the app Robinhood is appropriate. What is less obvious is who is being robbed.
Even the more “conservative” day-trading speculators who only trade market index options like the Standard & Poors 500 can roil markets in the short run. Currently, each time a share of index ETF symbol QQQ is purchased for speculation, around 36% of the funds flow into five stocks: Amazon, Facebook, Netflix, Alphabet (Google), and Apple. When the units are sold, the same happens in reverse. Given that day-traders go in and out of their positions so often (holding for 24 hours is considered long-term), their ongoing impact on a broad index is considered minimal compared to the short-term moves in certain individual stocks.
A study in England showed that almost 80 percent of day-traders lose money. In spite of this, the lure of fabulous gains brings them back and keeps them often going until their capital runs out. One immediately sees the parallel to gambling addiction. In fact, some people say that the current lack of professional sports activity is fueling day trading as there are fewer sports games to bet on. That will be proven with the passage of time. Until then, attempt to stay out of the sectors of the market that are even more over-valued than the market itself, which is not exactly a bargain right now based on historical metrics.
With the expiration of the $600 per week Federal Unemployment Benefit this week, and as of this writing no agreed-upon replacement, it would seem that the economy is heading to some sort of short-term contraction. With over 1.5 million workers laid off weekly, the economy currently appears in equilibrium between jobs coming back (such as in health care) and jobs being shed in hospitality, transportation, state and local government, and the like.
There is some hope of political compromise. It is understood that the President is in favor of another round of $1,200 checks per household (with his signature affixed). What rate, if any, the monthly unemployment rate will become is at this point anyone’s guess.
The going assumption is that everything is in holding until a vaccine can be developed and distributed. When this will be, and how long consumers and businesses can hold on is the question.
This past June, the federal deficit for the month was more than the entire year 2016. Fiscal year to date, the deficit is $2.7 Trillion, with three months to go until the end of fiscal 2020.
Much of the extra debt issued to finance this deficit has been purchased by the Federal Reserve. We are fast approaching a point when the ability of the Fed to finance the deficit may be running out of string. When that happens, who is next in line? China, who holds more US debt than any other country, is letting their portfolio mature while not making any more purchases. It is thus assumed that by the end of the year, interest rates will have to rise to find more buyers. Recalling 2018, the prospect of rising interest rates seems to be the issue the stock market is most afraid of.
As mentioned previously, the best place to look for inflation is in security prices. For its own reasons, the government does not do so. Based on goods purchased, inflation is rather tame, if rising. Services are less tame but also rising. Remember that this is in an environment where demand in many areas has been suppressed due to the coronavirus.
One development that bears watching is the decline in the value of the US dollar relative to other currencies. This has inflationary implications, as a cheaper dollar requires more dollars to buy the same volume of imports from the exporting country. This would permit domestic producers to raise prices, knowing that imports could not compete.
It would also make our exports more competitive, assuming a free market for such goods, as it would require fewer units of the foreign currency to pay for the domestic export. Thus a falling dollar may be good for business, but less good for the consumer.
The Stock Market
Since March, stocks as a group have shown an ability to rise almost regardless of the external environment. Many of the valuation yardsticks do not seem to apply to at least some sectors. How long this will continue is anyone’s guess. It is expected when the estimates for 2021 earnings come out in the fourth quarter, there may be some reality introduced to the equation. Until then, evaluation is the order of the day.
Warren M. Barnett, CFA
July 27, 2020
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