Risky roulette rides in the stock markets

When legendary mutual fund manager Peter Lynch hung up his boots, he decided to pass on his investing secrets to the average Joe. Lynch believed that with a bit of diligence and confidence, a small investor could end up being one up on Wall Street. One of the early lessons that he taught in his bestsellers was that one should hunt for bargains when the markets are falling. That’s when stocks are available cheap, below their intrinsic value.

There is a bigger tragedy hiding behind these crazy capers in the markets. When these junk stocks crash, as they are bound to at some point, a morality tale will be told to caution against governments giving money to the hoi polloi. We will be told that such excessive state spending leads to asset-price bubbles. Pundits will say governments must let the markets deal with such crises on their own.

Millions of retail investors across the world appear to have accepted this Peter principle as their mantra. Small investors are taking advantage of the Covid crash, and betting on beaten-down stocks like there’s no tomorrow. That is where their learnings about value-investing end. Unlike what gurus like Peter Lynch, Warren Buffett or Benjamin Graham prescribed, today’s retail investors don’t care whether these businesses are worth anything. These ‘Robin Hood’ investors — named after the zero-commission app most of them trade on — are putting their money on stocks that ‘smart’ money would reject. In fact, some of the most popular stocks right now are of companies that have warned that they are bankrupt — Hertz Car Rental or Chesapeake Oil. Along with these are companies that are the worst hit by the Covid lockdown — airlines, cruise liners, entertainment parks, retail chains — have all shot up.

Small investors are opening new trading accounts across the world. One reason is that families have got cash handouts from their governments, but there is nothing to spend it on. But, retail interest has peaked even in countries like India, where there has been no cash transfer. CNBC’s Prashant Nair reported that India’s largest retail investor platform, Zerodha, saw a 300 per cent jump in new accounts during the lockdown period.

Although middle-class incomes have collapsed, so has middle-class consumption, especially on restaurants and retail therapy. People are suddenly discovering that they were able to survive weeks without spending on anything other than essentials. This has left families with more cash in their hands, than they usually do. In the US, for instance, savings have gone up from $1.4 trillion in February to $6.2 trillion in April — almost a 450 per cent jump. Even in India, where middle-class earnings have dropped sharply, a recent survey by Credit Vidya shows that savings as a proportion of income has gone up.

What does one do with this extra money? Save it for the dark uncertain future? Keeping it in a bank is useless. Most central banks are now dishing out cash at near-zero rates. So, the next best bet is that casino called the stock markets. There’s also the thing about being stuck at home, in front of one’s computer or a smartphone screen. When Lynch was writing his books, stock market research usually required poring through company annual reports in hard copy, and doing valuation calculations on handheld calculators. Nowadays, you can get the latest information and news on the most obscure of listed companies. WhatsApp groups routinely share proprietary reports by storied brokerages. So, people locked inside their homes, with a lot of time on their hands, are trying their hand at playing the markets.

The reason why they have been buying junk stocks is because they are priced very low – not to be confused with being cheap in value. So, a small investor can buy many shares for a few hundred dollars. Even a 10 cent increase on a two dollar stock is a 5 per cent bounce. Those who could keep their greed in check, invested low and sold as soon as they got a decent return. Others have seen these stocks return to where they began.

The danger is that such roulette-rides in the markets drag in the latecomers, who think they must join the party. They enter when the stocks have already appreciated without any fundamental change in their business prospects. They end up buying high and lose all their investments when the stocks ‘correct’. We are already seeing this happen in several stocks, which have dropped sharply after a heady run.

On the other hand, when the global markets crashed after Covid-19 began to spread across the planet, it took down many good stocks well below their fair value. In some cases, the market capitalisation of some companies had gone below the cash they held in their books. It is a sign of the pessimism amongst the institutions that such stocks haven’t returned to their old levels even after the lockdown has partially opened. It appears that professional investors abide our question, while retail investors are free.

There is a bigger tragedy hiding behind these crazy capers in the markets. When these junk stocks crash, as they are bound to at some point, a morality tale will be told to caution against governments giving money to the hoi polloi. We will be told that such excessive state spending leads to asset-price bubbles. The pundits will say that governments must let the markets deal with such crises on their own. They will conveniently forget how the big banks and investment companies depended on government dole to stay afloat in the global financial crisis in 2008.

The author is a senior economic analyst