Part two of a two-part series.
Most traders of meme stocks — stocks that are discussed and heavily traded online — are speculators. They’re not analyzing the fundamentals behind specific stocks before investing in them. Like day traders, they are looking to make a quick buck.
The Federal Reserve Board has a major influence on markets.
Investment advisors and managers talk a lot about “fundamentals.” Ideally, a company’s sales, profits and other factors define its value and, therefore, its stock price. Companies that are well managed are rewarded with a higher stock price and investors are rewarded for buying their stock.
But that’s increasingly becoming a quaint, archaic ideal. It can be argued that traders using the WallStreetBets forum have been manipulating stock prices, but they are far from alone. Others have been manipulating the market for years without consequences, including the Federal Reserve Board and virtually all of Wall Street.
The Fed’s in charge. Dropping interest rates to zero, as the Fed did, creates an accelerant for stock prices and boosts the market. It started with unprecedented bond-buying during Ben Bernanke’s tenure as chair of the Federal Reserve Board during the financial crisis. It’s continued and even accelerated to this day.
The Fed under current Chair Jerome Powell started slowly increasing interest rates and even began to reduce its portfolio of bonds, but that was before the pandemic lockdowns changed everything. Now doves are soaring higher than ever.
As a result, stock prices have soared, even as the pandemic lockdowns have eliminated millions of jobs.
Algorithms run the market. Computers, and more specifically algorithms, are also manipulating the market.
CNBC noted that 80% of trades are now automated. Build a model, create an algorithm and let it run. Algorithms enable trading to take place in nanoseconds. And algorithms work at all hours, for no pay.
Quantitative funds — those relying on trend-following models instead of fundamental research — now account for 20% of the market. Passive investments, such as index funds and exchange-traded funds, control about 60% of the market.
Calling for an investigation by the SEC, Omega Advisors founder Leon Cooperman said computer trading is creating a “Wild West” with the markets.
Then there’s high-frequency trading, which we’ve written about previously. High-frequency traders use arbitrage, identifying price discrepancies and taking advantage of them automatically in nanoseconds. Their success depends on the reliability of their algorithms, not the insights and hard work of investment managers. High-frequency traders account for the majority of trades taking place in the U.S.
Michael Lewis’ book Flash Boys brought attention to high-frequency trading and he was quoted on “60 Minutes” saying that HFT rigs the stock market against the small investor.
Stock buybacks can boost prices. Companies have increasingly been boosting the price of their stock by buying back shares. Stock repurchases reduce the number of shares available, which typically boosts the price of remaining shares.
A study by Fortuna Advisors found that the 364 public companies with the largest repurchase programs by volume spent more than $3 trillion on buybacks during the five-year period ending in 2019.
The amount of capital companies expend on buybacks has grown at a compound annual growth rate of 10.4% since 2015, according to Treasury & Risk, which reported that $770 billion was used for buybacks in 2018 and $709 billion in 2019.
Buying Low, Selling High
WallStreetBets may be — or may have been — a market disruptor, but it is much less of a market manipulator than any of the parties mentioned above.
Participants may be making risky moves, especially when they leverage their investments with options, but they are also seeking to “buy low and sell high,” which is a great way to become wealthy.
The problem is, it’s impossible to know what “low” means. Stocks that are beaten down may look like bargains, but they are often beaten down for a reason and there’s no guarantee that they won’t continue dropping.
Small cap stocks that trade at low volumes are extremely volatile. They provide an opportunity to make money. But they also provide an opportunity to lose money. Proceed with caution.