The word “unprecedented” has been making frequent appearances in the financial media recently.

GME Stock On a Mobile Phone

Source: Shutterstock

Market observers are using the word to describe wild and crazy phenomena like the short squeeze that propelled GameStop Corp. (NYSE:GME) shares from less than $20 a share to nearly $500 … or the skyrocketing price of bitcoin … or the fact that so many troubled, money-losing stocks are soaring while their strong and stable counterparts are not.

These happenings seem so incredible and novel that they also seem unprecedented. But that’s not really true.

Novel, yes. Unprecedented, no.

First, let’s examine the novelties.

The “democratization” of investing that online communities like Reddit’s WallStreetBets are spearheading is certainly novel. Never before have individual investors been able to congregate with one another so easily and in such large numbers.

Once these congregations form, they can quickly and efficiently unify around a singular cause or objective and then rush into action. When these collective efforts succeed, they create a novel “flows before pros” effect.

The sheer volume of trade flows that the online communities generate overwhelms the professional investors on the other side of the trade … and effectively invalidates all the expert analysis that inspires and supports the professional positions.

That’s “flows before pros.”

A related novelty is what one might call the “gamification” of investing.

When online investment communities promote mob-buying of specific securities, they often do so in video game-like fashion.

As Bloomberg News explains:

[T]heir strategies include something akin to what gamers would call a “cheat code” – in this case, banding together and piling into individual stocks and related options the way a tight-knit team attacks a roomful of dragons in “World of Warcraft.” All with the goal of forcing short-sellers and derivatives dealers to buy the stock, pumping up its price beyond anything a traditional investor would consider reasonable.

These two novelties — the democratization and gamification of investing — are combining to accentuate a third novelty: short-termism …

Looking for a Good Time

Just like a fling bears little resemblance to a marriage, the WallStreetBets style of trading bears little resemblance to investing.

These traders aren’t usually looking to hold a given stock for a long time, just for a good time. They have little patience for … well … patience.

Their collective buying resembles a hummingbird that flits from flower to flower — pausing momentarily to draw a little nectar, then darting off in some other direction.

This “instant gratification” school of investing is accentuating a trend that has been intensifying for more than 50 years. Investors used to measure their holding periods in years, not months, but short-termism is pushing holding periods down to all-time lows.

According to New York Stock Exchange data, the average holding period for U.S. shares has dropped to less than six months, compared to nearly nine months one year ago.

As holding periods fall, volatility is likely to rise.

That’s because many of today’s stock market participants don’t simply want to be right; they want to be right, right now. And if they aren’t right, right now, they’ll bail out quickly and lurch toward some other promising trade.

This hyperactivity introduces an unpredictable influence that could easily boost market volatility.

Again, GameStop provides a textbook example. A buying panic propelled the stock from less than $50 to nearly $500 in just four trading days. But immediately after that brief peak, an equally powerful selling panic sent GameStop shares back down below $50.

That wild and crazy round trip first created $30 billion in new paper wealth, and then obliterated it … all in the blink of an eye.

“The U.S. has seen stock manias before, but nothing, it would appear, on the scale of the current frenzy,” The Wall Street Journal reports. “The magnitude of … stocks’ price increases … dwarfs what some longtime market watchers recall in previous speculative frenzies.”

The Journal’s characterization seems to perfectly capture the recent craziness in the stock market. But this quote was from a December 1998 issue, not a February 2021 issue.

The Journal’s cautious remark was referring to the stock market pyrotechnics of the bubble of the late 1990s. That spectacular bubble popped almost exactly one year after the quote above appeared, but not before brutalizing short sellers along the way … exactly like the high-flying stock market is doing today.

A January 26, 2021, news headline from Bloomberg reads: “Short Sellers Crushed Like Never Before.”

The reality, however, is that short sellers are being crushed like many times before.

A Highly Precedented Event

In March 1991, as the stock market was close to doubling from the lows of the 1987 crash, the Journal published a story about the short-selling Feshbach brothers.

It began with a riddle: What’s the difference between a battered short seller and a real bear? The bear knows when it’s time to pack it in and go into hibernation.

The story then detailed the harrowing setback the Feshbach brothers had suffered as the stock market soared to “crazy” levels.

The Journal explained:

[With] the stock market soaring, the Feshbachs have recently racked up overall portfolio losses of 35% to 40% …

One reason stocks have gone up, the Feshbach brothers say, is that a big short squeeze is going on. Translated, that means bullish investors are deliberately buying huge amounts of the stocks short sellers have targeted. The bulls supposedly set out to drive up the stocks’ prices, forcing the shorts to cover by buying shares at higher prices than they earlier sold the shares.

“Right now,” Mr. Feshbach says, “we wish we’d never heard of short selling.”

Today, only “old timers” remember the Feshbachs. But once upon a time, they were rock stars of the investment world, complete with their own private jet, which was more of a rarity back then.

But then their fortunes faded.

That’s because short selling is a very tough game that always faces formidable challenges … but not unprecedented ones.

Eventually, however, high-flying stocks lose altitude and head lower for a while … sometimes a long while. Following the big bull market of the late 1990s, the stock market tanked and spent the following decade delivering a return of less than zero.

From August 31, 2000, to August 31, 2010, the S&P 500 Index delivered a total return of minus 17%! The Nasdaq Composite heaped even worse abuse on investors by returning minus 45% over that 10-year time frame.

It’s hard to believe — or to remember — that stocks can be that cruel to investors for more than a decade. But it has happened more than once. It is not unprecedented.

The stock market always offers measures of both risk and reward, although not always in equal doses.

That’s why it is always essential to focus on both sides of the investment proposition, no matter how manic or depressive stock market conditions may be.

Here in Smart Money — and in my paid services, like Fry’s Investment Report — we maintain a consistent focus on the inseparable connection between risk and reward.

Obviously, we want as little of the former as possible, and as much of the latter as possible. That’s called “asymmetry”… and it is an essential facet of successful investing.

Online communities like WallStreetBets do not alter the imperative to insist on favorable risk-reward propositions. They simply add a new wrinkle.

Likewise, the novel influences coursing through the financial markets do not negate the value of disciplined investing. On the contrary, the heightened volatility these influences might promote, while unnerving, present excellent opportunities to invest near extreme market lows and to lighten positions near extreme, manic highs.

Bottom line: Be aware of these new influences, but maintain course and speed.

On the date of publication, Eric Fry did not have (either directly or indirectly) any positions in the securities mentioned in this article.

Eric Fry is an award-winning stock picker with numerous “10-bagger” calls — in good markets AND bad. How? By finding potent global megatrends … before they take off. And when it comes to bear markets, you’ll want to have his “blueprint” in hand before stocks go south.