There is no market revolution. Plus ça Change, Plus C’est La Même Chose (The more things change, the more they stay the same).
The global news media has focused on recent events in the US markets where large numbers of individual traders have pushed up stocks in which Hedge Funds had short positions. This was so successful that some stocks moved a few hundred per cent in a few days and some Hedge Funds made huge losses and the “small” traders (some of them had surprisingly large positions) seemed to have made some large profits.
The media loved it as it seemed for once the “Wall Street Elite” had lost big money and the ordinary Joe had won. For added symbolism – the fact that the brokers mostly used by small traders is called Robinhood Markets was an unbelievably generous gift from fate to the Media. Many commentators were pressed to opine on what these events mean for markets. More than one commentator suggested that there was a change in power order of markets and this hailed a new “democratisation of the markets”. These views are plain wrong. Circumstances always change – history does not repeat but it does rhyme – the key rules on long term investing do not change any more than the law of gravity does.
Long / Short Hedge Funds often have short positions in stocks they believe will go down. The difference this time was the identity of one of the Hedge Funds (Melwin Capital) that was short was publicised on a popular chat room and a call to go long the stock gained strong momentum. This success led individual traders to go long some other stocks which had significant short positions such as Blackberry, Bed Bath & Beyond and Macys.
On this occasion, the results were spectacular. However, the shares of Gamestop et al have predictably fallen back sharply last week and only those people who sold would have realised significant profits. Still stories of 20 year-old students making huge money in a few days make good headlines – no wonder two films on these incidents are reported to be in the pipeline.
Hedge Funds who lost money will be licking their wounds and will rein this risk for a while and be more circumspect about shorting. They will certainly try to cover their tracks more effectively. The WSB / Reddit traders will try and find a new way to make quick big money.
The whole saga shows the speed with which market trends can pick up in the age of the internet and the amount of money that can quickly be in play (WSB / Reddit is now reported to have 3.5 million members). In the old days before the internet or even in 1999/2000 when the internet was young, trends took a long time to build and bubbles built up slowly. The speed has increased greatly, the process is the same.
However, the idea that rules have changed and markets have been “democratised” (whatever that means)makes no sense.
There will be always be shot-term (or even mediumterm) bubbles and statistically there will always be some winner who will make big money (and brag about it – Twitter is full of people who make 50% a day before breakfast) – however what one needs for longterm success is a reliable consistent way to make money over long periods.
This is difficult to do as it requires a lot of hard work, a high tolerance for boredom and inactivity, a longterm perspective and (what is very important and often underrated) the ability to stick the course and avoid distractions along the way (of which there are too many).
As ever, the issues are nailed in the writings of Benjamin Graham and the investing journey of his best student, Warren Buffett.
Benjamin Graham said that “In the short term the market is a voting machine but in the long run the market is a weighing machine”.
What this means is that in the short-term, moves in the market will reflect popularity or lack of it. If a million traders on Reddit “vote” for a stock like Gamestop, it will go up for sure. Similarly, if a particular stock or sector is not popular, it can languish for a long time. So, in the short-term stock prices can do many crazy, irrational things like we saw last week and we should never be surprised by them.
In the long – term, however stock prices will always follow the profits and cash generated by the company. Companies that generate profits and cash flow will see that progress exactly reflected in their long-term share price appreciation. In the long term, the market is a weighing machine and Graham’s metaphor was well chosen – there is no way to cheat the weighing scales with quick fixes. It is what it is.
In the short term, the market is a zero – sum game, in the long run it is not. In the short run, the gains by the hedge funds exactly equal the gains made by the individual traders (net of brokerage and other costs of financial transactions). In the long run, as companies generate profits and cash – all holders will share in them in proportionate of their holdings.
Benjamin Graham supplied the core philosophical approach and framework and Warren Buffet assiduously applied it.
He has compounded his returns at a high rate for decades. Consistency and time are key. Avoiding permanent losses is more important than getting spectacular one-off wins. It is like the story of the Tortoise and the Hare – The Hare may be flashy and often wins many stages of the race but the Tortoise is the long-term eventual winner.
Warren Buffet is famously long term – He started investing at the age of 11 and is still compounding at the age of 88.
Buffet endures boredom and inactivity – he has held many stocks for decades and often spends weeks and months reading without a spreadsheet or a stock screen.
I would suspect that all times during his long-term career, there were always alternative investment strategies which for one or two years did much better than his approach. In 1999 /2000 as the dot.com boom raged, he was widely ridiculed as an old-fashioned investor who did not understand the “new” economy. In December 1999, Barron’s Magazine had a cover story with the title “What’s wrong Warren?”In recent years, as new technology stocks with no profits and cash flow have soared, there have been many ill- informed reports saying Value Investing is dead.
These things happen and there will be short-term underperformance. The difficult thing is to ignore the madness and stick with an approach that makes sense to you and you know is likely to work on the long term. The ability to ignore the noise and resist getting involved in the madness is critical and very difficult to do. The Gamestop et al saga is such a distraction and should be ignored.
Buffet illustrates this point with a joke which I will repeat to conclude this essay.
A Texan Oil prospector goes to Heaven and is met by St Peter at the Pearly Gates. St Peter confirms that his name is indeed on the list but he still cannot go in because Heaven is full. The oil guy is disappointed but asks St Peter if he can go and speak to his friends who he can see just behind St Peter. St Peter sees no objection to it and the Texan goes to the Oil Prospector corner of heaven and shouts “Oil discovered in Hell.” All the Oil prospectors run straight out of the heavenly gates and rush towards hell. The Texan goes back to St Peter. St Peter says “I do not know what you told the old oil guys back there but there is now definitely room for you in heaven so please be welcome!” The Texan hesitates and says “You know there might be some truth to that oil in hell rumour” and starts running furiously towards Hell.
The fundamental rules have not changed and will not change.