What happens when investors stop feeling pain?
1h ago · By Thomas Yeung, CFA, InvestorPlace Markets Analyst
- Investors seem to have become desensitized to risk and their own financial losses, especially since the meme stock craze of 2021.
- Increasing social media usage and a downtrend in financial literacy highlights part of the issue at hand.
- The internet seems to have broken the emotional feedback mechanism that’s integral to healthy investing.
What would happen if performance grading suddenly disappeared? No more dreaded annual job reviews… No grades at school… Maybe not even bathroom scales to give us bad news about our waistlines.
It would seem great.
But eventually, we know these systems would break down. There’d be no way to know how well we’re doing or what we should do differently. What would restaurants look like if no one could talk about how the food tastes?
Although most performance reviews and grades are not particularly helpful, the total absence of feedback would theoretically lead us to touch hot stoves repeatedly with no pain receptors to stop us. In other words, we need positive and negative feedback to help us navigate life.
But what happens when the internet obstructs that feedback?
This is a phenomenon I’ve found to be increasingly prevalent in the age of digital investing, especially after the 2021 meme stock bubble. Suddenly, assets with zero intrinsic value no longer create negative feelings among investors. Financial advisors now mostly shrug when clients ask about Dogecoin (DOGE-USD), an asset essentially devised as a joke. And fans of cult stocks like Tesla (NASDAQ:TSLA) or AMC Entertainment (NYSE:AMC) seem to have no issue when the stock falls 50% or more in a year.
Some investors take this even further. In certain online circles, owning money-losing stocks is viewed positively. Consider the recent collapse of Bed Bath & Beyond (NASDAQ:BBBY), a teetering corporation where bankruptcy was clear months in advance. Shares of BBBY stock were pumped up on social media right until the very end. It’s as if the negative news and slumping share price had no effect on shareholders.
Getting the right feedback is essential to helping us learn. Positive events like earning “A” grades nudge us to succeed more. And negative things — like losing money on a speculative stock — create painful memories that help us avoid future mistakes. But meme stocks and technology seem to have turned this logic on its head.
How did the internet short-circuit our feedback mechanisms? And what does it mean for the next generation of investors?
Building the System…
To understand how the internet has broken our emotional feedback in investing, we should first examine its rise.
In its early days, the worldwide web was a game-changer for regular investors. In less than a decade, we went from ordering stacks of paper annual reports to being able to download them from the U.S. Securities and Exchange Commission’s (SEC) EDGAR website. AOL and Yahoo brought free financial information to the masses while online chatrooms made creating groups to discuss investing ideas effortless.
It wasn’t a perfect system. These emerging technologies were clunky and prone to misreporting data. Companies like InvestorPlace’s forerunner, Stansberry Research, emerged to organize the information and help make sense of it all. Also, for every reputable upstart, plenty of hucksters joined the fray. In 2000, 19 individuals were charged in a $8.4 million chatroom scam. Teenagers could use this new online medium to pump stocks and sell out while at school.
Still, the internet was far better than the “old” way of doing things. In this new world, even the most novice investors could access much of what a Bloomberg Terminal provided. Even the dot-com bubble of the late 1990s could only slow progress, not stop it entirely.
Adopting the Sarbanes-Oxley Act in 2002 helped standardize financial data for better online use. And the financial crisis spurred the rise of many low-cost fintech alternatives, such as YCharts in 2009, Finbox in 2015 and Koyfin in 2016. The latter set out to “revolutionize the industry by building a platform that puts the user in control […] all at a price that doesn’t alienate individual investors and students.”
It’s hard to emphasize how far we’ve come from the annual thousand-page manuals that Moody’s once published.
…And Taking It Apart
For a while, the benefits of new online technologies eclipsed their downsides. Websites like Barron’s commanded heavy readership, helped by solid reporting from well-vetted analysts. Investors looking for a DIY approach had no shortage of reputable websites to consume. It was a golden period for forums like Seeking Alpha and ValueInvestorsClub, where professional and part-time investors could give their “off the books” recommendations backed by lengthy research missives.
But behind the scenes, two changes began to happen.
The first was the rise of Robinhood (NASDAQ:HOOD) as a “gamified” trading platform. By obscuring trading fees deals and sprinkling confetti every time investors traded on its slick mobile app, Robinhood began severing the link between investing and performance feedback. Suddenly, buying stocks was fun, regardless of what you were acquiring or how the stocks performed. Today, Robinhood still defaults to a 24-hour return window, making even the worst-performing portfolios look “green” at least every other day.
The second shift was the rise of social media — a medium initially used for posting cat photos, not for finding the latest stock tip.
That began to change in the mid-2010s with the rise of the influencer market, a segment where trust matters far more than truth. Online celebrities started blurring the lines between paid endorsements and genuine opinions. Many viewers were none the wiser. By 2017, Instagram’s influencer market alone was worth around $1 billion.
It was only a matter of time before the online celebrity wave began spilling into financial products… and even individual stocks. Today, top “finfluencers” can earn $500,000 or more annually for promoting everything from robo advisors to how to spend your money. Financial products can get pumped without celebrities believing a word they say, an issue explored in depth by many.
Of course, ordinary investors would also play a part. Social media in 2020 was filled with discussions on how people would spend their “stimmies,” the $1,400 stimulus checks from the Covid-19 pandemic. And much like the finfluencers, there was often a disconnect between what people said and what they truly felt.
The stage was set for the internet to sever the link between investment performance and emotional feedback.
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GameStop 2021: The Watershed Moment
The mayhem began in January 2021, when users on the Reddit forum r/WallStreetBets began piling into GameStop.
At first, investors on social media had good reason to love the struggling video game retailer. Online pet company founder Ryan Cohen had just bought an activist stake in the firm and promised to transform GameStop into an e-commerce giant. Shares of GME stock were also dirt cheap. The company traded at a 0.30 price-to-sales (P/S) ratio, about 88% lower than the typical S&P 500 stock today. Look hard enough and it becomes obvious why at least one speculator was willing to put seven-figure sums on this low-priced stock.
But none of this had to resonate with newer GME investors. To them, it became a game of taking down short-selling hedge funds by buying shares of a stock no one wanted.
That meant GameStop became more attractive as prices rose. For every dollar GME stock went up, speculators could celebrate that millions more were getting squeezed from Melvin Capital and its backers. It’s the opposite of what traditional value investors believe.
And thus began a cycle where emotional feedback became detached from the investment decisions. To these novice investors, there was no pain in buying GameStop at $100… $200… or $400… even if you risked losing it all on the way back down. Instead, the satisfaction of finding a like-minded community to bankrupt hedge funds was enough compensation. When prices did fall, the distress of losing money wasn’t enough to counteract the ecstasy of one-upping Wall Street.
In a single instant, the internet had short-circuited investment fear itself.
Finding the Next GameStop
Most alarmingly, certain online communities began seeing these “meme stocks” as badges of honor. In these circles, buying shares of these low-quality stocks became almost a rite of passage. It didn’t matter if you made millions or lost it all. The only important currency was the kudos gained from fellow online investors.
That meant novice investors searched for the next GameStop long after losing money on the original. Cannabis stocks… mobile phone makers… joke cryptocurrencies… no struggling industry became too terrible to buy.
Consider Mullen Automotive (NASDAQ:MULN), an electric vehicle (EV) startup that routinely sits in the top-five most-mentioned stocks on Stocktwits.
From a fundamental standpoint, there’s little that’s attractive about Mullen. Since going public in 2021 through a reverse merger, the company has managed to burn through at least $210 million of cash without delivering a single Mullen FIVE. Instead, it has provided a constant stream of questionable press releases, enormous shareholder dilution and outsized pay packages for insiders.
MULN stock has declined roughly 99% since its reverse merger.
To ordinary investors, these losses should have burned a painful memory into their minds. There’s a reason why toddlers don’t touch hot stoves twice.
Nevertheless, Mullen remains incredibly popular among its dedicated fans. Every press release is met with a flurry of trading activity and moderators routinely scrub negative comments on the r/Muln subreddit. No matter how far MULN stock falls, its fans always find a new reason to reach for that red-hot stove.
Fooling You Once, Fooling You Twice
These communities have created spaces where investment losses no longer equate to negative emotions.
Unscrupulous managers have quickly pounced on this fact. In January 2023, shares of Genius Group (NYSEMKT:GNS) spiked 120% after the Singapore-based firm announced it had appointed a former FBI deputy director to investigate alleged naked short selling — a practice where investors sell shares they don’t have. Management knew they were blowing a dog whistle for meme traders. And speculators were happy to oblige.
Other struggling companies soon joined the fray. Helbiz, Nuvve (NASDAQ:NVVE), Coeptis Therapeutics (NASDAQ:COEP), Mangoceuticals (NASDAQ:MGRX) and many more penny stocks quickly announced plans for similar investigations.
Even reputable companies have succumbed to this new style of pandering. After shares of online media firm BuzzFeed (NASDAQ:BZFD) rose 120% on announcing usage of ChatGPT, companies from Snap (NYSE:SNAP) to Shopify (NYSE:SHOP) joined in. The rise of social media has helped firms amplify these messages to a startling degree.
How to Fix the System
Obviously, there’s no straightforward solution to this issue. Requiring every online commentator to hold beneficial ownership of recommendations would be a logistical and legal nightmare. It also wouldn’t solve pump-and-dump schemes where hucksters sell after they’ve finished promoting a stock online.
Banning stock chatter on social media would be no better. Investors have become used to seeing stock due diligence boil down to a 140-character tweet. Thousand-word reports on the merits of a particular stock are an increasingly rare way for anyone to consume information.
That leaves several options that face long odds.
First, there’s investor education. The U.S. education system could start mandating investment courses at the high school level to recreate a link between good investing practices and positive financial returns. That could mean giving students money at the start of their high school career and allowing them to invest it as they please. Or perhaps simply teaching the basics of personal finance to help students get started.
But there are issues with this idea. The links between high-quality, high-growth companies and positive returns are relatively weak. According to my research, even top investors should expect only 3% to 8% of outperformance per year — a significant sum over a working lifetime but barely a difference in the four years of high school. And financial literacy courses have remained contentious. Billy J. Hensley, President and CEO of the National Endowment for Financial Education, notes that partisan politics and sloppy policymaking have hamstrung well-intentioned financial education efforts.
Second, there’s regulating social media. Sites like YouTube and Reddit could begin vetting users who dispense financial recommendations. And the SEC could clamp down on celebrities — like Tesla CEO Elon Musk — who take to Twitter to promote investments like Dogecoin.
That, too, faces extreme hurdles. What’s to say it’s not free speech?
Then there’s one final idea: Regulating what companies can tell investors. This promising solution would hold boards and management teams to higher standards when disseminating information. Bad actors that pump shares of their company could face legal consequences.
There’s already some framework for such regulations. The Sarbanes-Oxley rules require CEOs and CFOs to sign off on financial statements. The prospect of jail time for certifying false statements has significantly improved corporate governance. The SEC also has some leeway in suing companies for making false statements. In 2018, Elon Musk was forced to resign as chairman and pay a $20 million fine after falsely announcing he had “funding secured” to take Tesla private.
Still, it will be an uphill battle. The SEC lost a secondary lawsuit to the “funding secured” tweet earlier this year. It will always be challenging to tell legitimate CEO optimism apart from misdirection.
Where to Go From Here?
This will come as unfortunate news for Gen Z investors. Social media has only grown in prominence, making it harder to ignore online commentary. In 2012, the average person spent 90 minutes per day on social media. Today, that figure is closer to two hours and 31 minutes daily, or roughly a third of all time spent online.
Meanwhile, financial literacy has only fallen. Just 25% of American teenagers now have confidence in their personal finance knowledge, a figure that has dropped significantly since the Great Recession. It’s a worrying combination that could bankrupt a generation of investors.
Still, the internet does have the means for recreating a link between investment decisions and ultimate performance. Many fintech firms mentioned before have sophisticated performance attribution systems designed to tease “alpha” from random luck. And the internet is still making it ever-easier to access information if you know where to look.
I hope everyone manages to achieve this. Because the only way to avoid repeatedly touching that metaphorical hot stove is feedback — a link between the quality of investment decisions and their ultimate performance.
As of this writing, Tom Yeung did not hold (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.comPublishing Guidelines.
Tom Yeung is a market analyst and portfolio manager of the Omnia Portfolio, the highest-tier subscription at InvestorPlace. He is the former editor of Tom Yeung’s Profit & Protection, a free e-letter about investing to profit in good times and protecting gains during the bad.