Is Today’s Genius, real Genius, or Tomorrow’s Fool?

If you’ve been paying attention to the news at all in the last few days, it is practically impossible to ignore discussion and commentary around stocks like GME, NOK, AMC and others. That’s what happens when a stock doubles in price in one day, then does it again the next day. If you’re like me, you saw those movements and wondered what the heck was going on.

Despite what I do for a living, my interest in the financial markets isn’t something that has extended to my family. My own mother calls my book, “A Trade for All Seasons” the best cure she’s ever seen for insomnia and returned the copy I gave her when I first published it thinking that, even if she didn’t want to read it, at least it would give her something to show off to her friends. My wife’s eyes start to glaze over when I start talking about the market and economics in front of her, and my sons usually just shrug their shoulders and go look for something else to do. 

I’ve come to accept the fact that there is a very specific group and type of person that what I do appeals to, so I was a little surprised yesterday when my youngest son texted me to ask me for my take on what was going on. He works in retail sales right now, and the TV in his store that usually gets put on sports was tuned to the market since that is where all the action was. The surge in price for NOK had also gotten enough of his attention that he decided to buy some shares in that stock, and he was feeling pretty great for having gotten in a little above $6.

While I haven’t been following the discussion about these stocks beat-for-beat, I have paid enough attention to try to figure out what has been driving these big moves in companies that most fundamentally-oriented investors would be ignoring. The revelation that retail investors were driving a big part at least of the initial move in GME was interesting, especially when it was found that many of those investors were sharing their trades with others on social media platforms like Reddit and Discord to name just a couple. Retail investors as a rule don’t really have a lot of power in moving stock prices because, let’s face it, individually our trades aren’t big enough to really make a dent, and there usually just aren’t enough of us doing the same thing, in the same way, or at the same time to get a “groupthink” kind of element to come into play.

In 2020, there were a couple of interesting, but out-of-left-field exceptions, such as when the stock price of Hertz, which was bankrupt and trading at penny stock levels, got a quick near-term bump into low-priced stock levels when a bunch of Robinhood users started buying it. That turned out to just be a retail version of a “pump-and-dump,” because after that the stock dropped back again; the stock has since been delisted. The only other notable example was in Eastman Kodak, which followed a similar pattern in August of last year but has mostly been holding below $10 since then. These examples didn’t have the same kind of coordinated effort, though which is why I think that the stocks eventually just dropped back to more normalized levels and left TV’s talking heads and “experts” just shaking their heads at the foolishness of the retail investing crowd.

This move has been different, not only by the way people encouraged each other to buy shares at the same time, but also in the way they chose the stocks they wanted to pump. GME, for example was targeted because it was easy to see that short interest (the number of investors selling the stock short on the bet it would drop) has been significantly higher than the total number of shares outstanding for quite some time. Some particularly noteworthy hedge fund managers had large short positions in GME and AMC in particular, and it seems that some of these retail investors decided to use the momentum their collective buying could create to stick it to those managers.

At one point yesterday morning, I turned my TV to CNBC and caught the tail end of an interview with the CEO of Social Capital, who was somebody that had bought GME at the early portion of its surge and was happily telling people about having gotten out near the top earlier in the session. The CNBC commentator was questioning the value of these kinds of highly speculative moves and the real risks they presented to typical retail investors, and Social Capital’s CEO was responding in an equally aggressive fashion, defending the moves as retail investor’s opportunity to level a playing field that is traditionally, almost overwhelmingly tilted against them.

I don’t know where all of this is going to land; is this an example of dangerous speculation, bordering on manipulation of stock prices that should be regulated against? Perhaps. At the same time, I have to admit that I kind of chuckle at the idea of seeing some hedge fund fat cats getting fed a dose of their own medicine. These are companies that specialize in bearish bets, and in the case of GME, they seemed to be betting the company would be the next Blockbuster, the video store titan from the ’80’s and ’90’s that the shift to streaming, on-demand video completely wiped out. It isn’t illegal, and it can be argued it isn’t even unethical – but it does mean they’re betting on real people losing their livelihoods, and they’re making bank when they’re right. So I’m not sure that having that script flipped decisively against them is an altogether terrible thing.

Even so, I think there is a real danger when this kind of activity starts to happen, because then other, less-informed and educated investors like my son start to think they’ve found a path to “easy money.” That’s why when I was talking to him yesterday, I decided to throw a catch phrase at him. “Be careful,” I said, “that today’s genius doesn’t turn into tomorrow’s fool.” I can’t take credit for thinking it up; I think it just means that I have watched Star Wars (Obi-Wan Kenobi: “Who is the more foolish, the fool or the fool who follows him?”) a few hundred too many times.

“Don’t worry, Dad,” my son assured me. “I’ll get out as soon as I’ve doubled my money.” It’s a good thing weren’t talking face to face or he’d have seen me shake my head and rub my temples. That led me to talk about not getting greedy and understanding that some profit is better than none. Given the pace of the increase in NOK (it peaked yesterday above $9 and was around $7 when we had this conversation), I explained that, even if there wasn’t GME-level manipulation going on, that kind of pace was unlikely to be maintained consistently. I warned him to look out for a peak and drop back as a sign that people were taking profits, and that might be a good time for him to think about following suit, and then it was time for another catchphrase. “Pigs get fat, hogs get slaughtered,” I told him.

Today, it might look like I was being prophetic as GME has been down as much as -50% today, and NOK has taken back all of yesterday’s move and is a little below $5 as of this writing. That isn’t the point of today’s post; the real point is that as retail investors, there is a real temptation to do as my son did and jump on the bandwagon to do the latest, sexy-sounding thing. Looking for massive short-interest, and then going long could sound like a cool way to make easy money if enough people get behind it; but the saying “there is no free lunch” applies to the markets as much as anything.

The last time I saw anything resembling the extreme, hard-to-explain kind of swings from very short-term swings from high to low was during the “dot-com boom” that went “bust” two decades ago. I remember seeing a massive number of tech companies with not much more actually going on than a .com in their name going public, and there were a lot of conservative-minded analysts and talking heads out there questioning the legitimacy of these businesses and the irrational exuberance being shown by the enthusiastic buying of practically any stock with ties to the World Wide Web and the then-uncharted territory of e-commerce. I remember a lot of those critics getting shouted down, with bullish investors and analysts saying that the market had changed and those dinosaurs needed to catch up to the times and realize that the paradigm the markets operated on was changing.

Two decades later, we can look back and agree that the Internet did indeed introduce a new, innovative paradigm into the economy and the markets; but along the way most of those ultra-sexy names collapsed under the weight of the “dot-com bust” of 2000. My take away from that experience was to reinforce the idea that new ideas are good, and could even be great, but it is a fool, not a genius that simply assumes that those new ideas mean that the path to financial wealth is easy.

I’m not saying that those investors that jumped on the GME bandwagon were wrong, or necessarily foolish. I’m not even saying that my approach is better or smarter. I am saying buying too much into the latest sexy idea often makes people cast aside caution and common sense, and it tempts them to take overly dangerous risks. In my son’s case, I’m grateful that he at least didn’t invest money he couldn’t afford to lose. Hopefully, this proves to be useful educational experience for him about the risk of being too aggressive and what “good enough” really means about how and when to call a win, a win. These kinds of fads seem to come up every so often in one form or another, and my own experience in getting burned by them is the reason I’ve settled back on time-proven principles based on fundamental analysis and high value, driven by a focus on conservative, consistent income generation rather than on making the most money possible.

 I don’t know what the fallout of the last few days will or won’t be; but it’s safe to say that for every Social Capital CEO that made out like a bandit on GME there are probably hundreds or even thousands of other average Joes that will end up on the short end of the stick. That means that being aggressively speculative in these kinds of situations will almost always make you tomorrow’s fool – not today’s genius.

If you are a new subscriber, please take some time to review the videos in the Getting Started area of the website. These will give you a pretty comprehensive view of the value-oriented approach I use to generate income with put selling and covered calls. You will also find it useful to read my Frequently Asked Questions article. Also feel free to review my previous posts as you’ll find additional answers to many of the questions you may have.