As anticipated, Wall Street wins once more. In 2020 and 2021, retail traders had been chasing monetary markets recklessly. Armed with websites like Reddit WallStreetBets and a Robinhood buying and selling app, to not point out younger investing mentors on social media, they believed that they had the Wall Street “tiger by the tail.”
In January, we warned traders (largely falling on deaf ears) that 2022 would doubtless be disappointing. To wit:
“From the mainstream media’s view, expectations are high that 2022 will be a continuation of 2021. Maybe such will be the case. However, as we laid out just recently, many of the headwinds that supported the ramp in speculative behaviors have, or will, reverse in the months ahead.”
- Tighter financial coverage and excessive valuations.
- Less liquidity globally as Central Banks gradual lodging.
- Less liquidity within the financial system because the earlier monetary injections fade.
- Higher inflation reduces consumption.
- Weaker financial development
- Weak client confidence attributable to inflation
- Flattening yield curve
- Weaker earnings development
- Profit margin compression
- Weaker yr-over-yr comparisons of most financial knowledge.
“As is always the case, the event that changes the “bullish psychology” is always unknown. However, the eventual market reversion is almost always a function of changes in liquidity or a contraction in earnings.
Most notably was the concluding sentence.
“Heading into 2022, a evaluate of 2021 can undoubtedly present some clues as to what probably occurs subsequent. Notably, “record levels” of something are data for a motive because it denotes the final interval earlier than the eventual reversion.”
In 2020 and 2021, we saw record IPO and SPAC issuance levels. Wall Street was happy to feed the stimulus-check-fueled feeding frenzy of retail investors.
Everyone forgot to ask, “why am I so fortunate to get entry to this funding?”
Wall Street Wins Again
It was interesting to hear retail investors crowing in chat rooms about how they were beating Wall Street at their own game. Such is not surprising given the massive gains retail traders made by taking on an excessive amount of risk and doing so with leverage.
As shown below, investors were eager to buy the IPOs of companies even though most of them generated no profits.
Special purpose acquisition vehicles (SPACs) were relatively unused until the firehose of pandemic liquidity spurred Wall Street capital markets teams into action, forming hundreds of companies to raise billions of dollars of equity in these so-called blank-check offerings.
However, as noted, retail traders forgot to ask WHY Wall Street offered this incredible opportunity to invest in these start-up companies? After all, if these companies are so valuable, why wouldn’t Wall Street keep these prized possessions?
But in a “speculative market,” such is not surprising. What is not surprising is how it ended.
There are still over 950 SPACs seeking to raise $239 billion from investors. Of this, $207 billion worth haven’t even found a target. Since the beginning of 2021, most of these SPACs are now underwater.
In hindsight, we now know that only Wall Street benefited by dumping a supply of speculative products to retail investors armed with a stimulus check and a trading app. Wall Street reaped the rewards of bringing these companies public and selling their shares at premium values to unsophisticated investors under the well-crafted story of “innovation.”
Not surprisingly, retail investors lost. Wall Street wins.
But, as shown, by the end of 2021, most IPOs and SPACs failed to work as well as hoped.
Lessons Learned And Relearned
The amount of speculation in the market in 2020 and 2021 was a warning sign that was easy to see. Yet, no one did. However, such is always the case when investors allow greed to trump basic logic.
As we noted then:
“The three most important market dangers heading into 2022 are a reversal of the issues that supported the speculative perspective of traders over the past yr: buybacks, liquidity, and earnings development. Notably, the reversal of liquidity impacts each side of the financial system and markets, and earnings are the “bullish support” for overvaluation.”
Such was the case in 2022, which had the worst start to any trading year since the Great Depression.
As is always the case, investors must often relearn lessons the hard way during market cycles. Long bullish advances desensitize investors to the risk they are taking. Investors can take on leverage or buy poor fundamentals, and rising prices will cover those mistakes.
Unfortunately, when the “tide finally goes out,” those mistakes are revealed in the most brutal of fashions.
Such is why, as an investor, the most important investing attribute is to step away from your “feelings” and look objectively at the market around you. As Howard Marks once quipped:
“In good instances skepticism means recognizing the issues which are too good to be true; that is one thing everybody is aware of. But in unhealthy instances, it requires sensing when issues are too unhealthy to be true.
The issues that terrify different folks will in all probability terrify you too, however to achieve success an investor needs to be stalwart.
After all, more often than not the world does not finish, and in the event you make investments when everybody else thinks it’ll, you are apt to get some bargains.“
How you choose to manage your portfolio is entirely up to you. Every investment strategy has a consequence and will lose money from time to time.
The only difference is the amount of the loss, what causes it, and what you do about it.
Editor’s Note: The abstract bullets for this text had been chosen by Seeking Alpha editors.