The world is changing fast and to keep up you need local knowledge with global context.
Dr Richard Smith is an expert on cycles and the CEO of The Foundation for the Study of Cycles, a not-for-profit. He speaks to BizNews about what is really fuelling ‘meme’ stocks – and catching out professionals – and what this means for investors outside the Robinhood community. Dr Smith shares where crypto currencies fit in and sizes up whether US markets really are in a bubble – and what the implications may be for investors in shares listed on stock markets in Africa. – Jackie Cameron
Dr. Richard Smith on the changes in the market:
I don’t think a whole lot has changed, actually. I think the biggest thing that has changed is that the retail investing world has been really influenced by a business model between the retail investors and the market makers, known as payment flow or order flow. I think that Robinhood and Citadel Securities have really opened the floodgates to retail investing for free – or apparently free.
What’s going on behind the scenes is that Robinhood and Citadel and others are highly incentivised to just have the public transact. That has really influenced the transactions that the public has been encouraged to engage in. Robinhood has gamified free trades and options trades, and they make hundreds of millions of dollars off of selling orders to market makers. They do it based on the percentage of the spread that they deliver to market makers, so they can talk all they want about democratising investing and about being for the little guy, but there is a moral hazard in their business that is built upon their incentive to have their customers transact at the widest possible spreads.
That’s how Robinhood gets paid the most money. The market makers have been more than happy to take that order flow, often times to be able to make their own moves ahead of that order flow. I think that’s been a big part of what has driven this frenzy. To me, it’s all part of a disconcerting movement, I guess, in our world of these technology platforms that are really incentivised on engagement and growth, and have little regard for the value that they deliver to the actual users of the platforms – because their users are not their customers.
Robinhood’s customers are not its users. Robinhood customers are the market makers who pay them over – I don’t know exactly how much – but estimates are at least half of their revenues come from payment for order flow. Just like Google users aren’t its customers. Big advertisers are the customers of Google.
On the US stock market:
I am concerned. I was around in 1999 and 2000. This feels very familiar to me. From a cycle perspective, it feels familiar to me. On the other hand, I do think that there are a lot of positive economic tailwinds. There’s been a lot of savings, surprisingly, during the pandemic. I think with the vaccine taking hold that there is an opportunity for the economy to recover.
But I think there are real signs of speculative excess. What concerns me the most, is that there could be another cycle of retail investors getting decimated and crushed and turned off from the markets for a generation. That, to me, is the risk of Robinhood and others.
On the one hand, they’ve done an incredible job providing easy to use technology to give people the opportunity to engage in the markets. I just don’t think that it’s happened in a way that really facilitates long term success and resilience, in terms of market participation. I think it’s really encouraged speculation. When there’s excessive speculation on the retail side, my experience is that usually ends badly for the retail side of the equation.
On how people should manage their risk:
I think those who want to succeed [in the] longer term really have to tune out a lot of this. So much of succeeding in the long-term is about managing your expectations of what your reward and risk is likely to be over the long-term. So this is a time where there, I think, is elevated risk in the markets right now. Does that mean you should pull out all your money and run for the hills? No, but you do have to understand that there is elevated risk. That we could see a 50% drop in the markets. That’s not out of the question for 2021 – it’s not out of the question for any year. That’s the reality of being in the markets. So do I think the odds are a little higher of something like a 50% correction in 2021? Yes, I do.
On the effects this has on African stock markets:
I think there is a risk – a heightened risk – in illiquid investments. I would say some of Africa’s markets are illiquid markets. So I do think that there’s a risk of manipulation. I don’t really know what’s going on in social media so much in Africa. If there is the opportunity for something like what WallStreetBets did with some heavily shorted stocks here in the US, so it’s hard to say. I do think that it is a time that everybody needs to recognise that there is an elevated risk. There’s a lot of disruption and a lot of unrest going on globally right now and a lot of changes going on in the world.
That leads to heightened opportunities for volatility. I think volatility is part of being in the markets. If you’re not prepared for it, you shouldn’t be in the markets. Again, it’s really – to me – always a matter of knowing your time horizon, how much capital you have and how much risk you’re willing to take with that capital. So I think there are incredible opportunities in Africa. I personally am excited about Africa.
The more research I’ve done, the more I see it as an incredible opportunity. But I think it is a longer term opportunity – like a five to 10 year opportunity. I think that anybody that’s really serious about investing in the future of Africa – as opposed to just speculating on up and down short-term moves – should be thinking in a five to 10 year horizon and being just fine with your investments falling 50 percent during that period of time. But ultimately with the opportunity of making, 1000% or more.
On what the frenzy may do to companies like Apple and Amazon:
I really don’t think it’s going to do much of anything. I really think that this GameStop episode is going to pass over fairly quickly. I think it’s already happening. I think it’s a relatively small portion of the market. Yes, it has been eye popping and attention grabbing. But in the end, I don’t think that it’s going to have a big structural impact on the markets. If anything, I hope that it leads to some more transparency facilitated by the regulators and a little bit of sobriety.
I’m a fan of cryptocurrency and blockchain myself. I am on the one hand expressing some skepticism about the David versus Goliath story here, and I think it’s an educated skepticism. On the one hand, I really am supportive of the idea of David versus Goliath, and I think that Bitcoin and other cryptocurrency have been part of that story.
I just think it again, it really is a matter of understanding the relationship between reward and risk. There’s a lot of risk in Bitcoin right now when it goes up a few hundred percent in a short period of time. And does that mean it can’t go 100% higher? Absolutely not. But it could also fall by 50% just as easily. One of the interesting things going on in the Bitcoin world is this idea of not selling. People who buy Bitcoin oftentimes don’t sell it.
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