NEW YORK – The trading frenzy this week over high-flying stocks like GameStop, AMC and Tootsie Roll has sparked concerns that the stock market is headed for a bubble resembling the dot-com boom and bust in 2000.
The swings have left some mom-and-pop investors shaken up. Now they’re worried about how to shield their nest egg if the supposed bubble expands and bursts.
Wall Street experts and money managers have some advice: Fear not.
“If you’re a long-term investor, you shouldn’t lose a lot of sleep at night over your 401(k),” says Dan Kern, chief investment officer of TFC Financial, an investment management and financial planning firm in Boston.
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But buyer beware. While some small-time investors who have speculated on shares of GameStop and AMC may cash in hefty returns, it’s only a matter of time before the prices of these stocks collapse and a reckoning occurs for the investors who own them, he adds.
“Manias like this usually end in tears,” Kern said. “I’m reminded of some of the things I saw in 1999 where people told me they were making more money day trading than from their jobs. By 2001, very few of them were still day trading.”
GameStop, AMC and several other companies have become targets for many online investors who have sent their share prices skyrocketing in recent days, taking on big hedge funds who have bet those same stocks would fall.
Shares of GameStop continued to ascend Tuesday after Tesla chief executive Elon Musk tweeted a link to a Reddit thread about the company.
On Wall Street, the situation has become a battleground where swarms of smaller investors see themselves fighting the 1%.
The way they’re doing that by targeting large financial firms that are short selling, a strategy where hedge funds make money by betting that share prices will fall. These investor funds earn by identifying a stock expected to drop in value, then borrowing shares from another investor and immediately selling them.
By the time they need to return the shares, they hope to buy the stock back at a lower price after it drops in value, making a profit on the difference.
In this case, several smaller investors banded together through the Reddit forum WallStreetBets to help drive GameStop shares higher. The result could hurt hedge funds that had planned on shares falling. Instead, they have to buy back the stock at much higher prices.
“There’s an element of populism and frustration with the 1%,” says Ed Clissold, the chief U.S. strategist at Ned Davis Research. “To think that non-professional retail investors are sticking it to the hedge funds smells like class warfare.”
The funds serving the financial elite are starting to walk away in defeat. Big bets they made that GameStop’s stock would fall went wrong, leaving them facing billions of dollars in collective losses. All the wild action pushed GameStop’s stock as high as $380 on Wednesday, up from $18 just a few weeks ago.
GameStop and other stocks like AMC Entertainment fell sharply Thursday after Robinhood and other trading platforms restricted trading in them. The chaotic trading action is drawing calls from Sen. Elizabeth Warren and others for regulatory action to curb the frenzy. GameStop shares shed 44% Thursday to close at $193.60.
Is this a sign of a bubble?
Big picture, this isn’t a classic bubble, argues Brad McMillan, chief investment officer at investment adviser Commonwealth Financial Network. But that doesn’t mean that the broader market isn’t susceptible to a pullback in the coming months after rebounding to records.
“Even in the absence of a bubble, markets can drop significantly, as we have seen multiple times in the past decade,” McMillan said in a note. “Bubble or not, we can certainly expect more volatility, because whatever happens with interest rates or sentiment, that is one thing that will not change about markets.”
“It’s bubble-like behavior. But usually, when we talk about bubbles, they’re large groups of stocks that create more systemic risk to the broader market,” says Clissold. “At this point, it’s just a handful of stocks.”
Don’t freak out, yet
“The market can stay irrational longer than you can stay solvent,” John Maynard Keynes, the influential British economist, once quipped almost a century ago.
The meteoric rise of these speculative stocks has drawn comparisons to “irrational exuberance,” a phrase coined by former Federal Reserve Chairman Alan Greenspan on Dec. 5, 1996, when he spoke about the internet bubble in the stock market. This exuberance happens when investors are so confident that the price of a stock will keep rising that they lose sight of its underlying value.
To be sure, long-term investors could miss out on gains if they sit on the sidelines out of fear.
For instance, the S&P 500, a benchmark used to track most mutual funds, advanced 105% from the date Greenspan uttered his famous phrase in1996 until March 24, 2000, when the index peaked before bursting, according to Clissold.
“The market could dip in the next few months,” Kern said, “but that will probably be a buying opportunity.”
The S&P 500 has surged 70% to records since hitting a low on March 23 following a pandemic-fueled selloff last spring. After a big run, it could be time for a break, argues Ryan Detrick, chief market strategist at LPL Financial.
The current bull market, for instance, has tracked the start of the 1982 and 2009 bull markets similarly so far, Detrick said. Both of those took a break for a few months starting around this point in the cycle, he added.
Stocks have also historically struggled from late January until early March when a new party is in power in the White House since new policies typically add to investor uncertainty, he said.
“While these developments could be another sign of excessive optimism in certain segments of the equity markets, we do not believe they represent a sign of a broader market bubble or indicate a major correction is forthcoming,” Detrick said in a note. “Don’t forget, overall market breadth is extremely healthy and the credit markets are functioning just fine – we don’t see a repeat of 1999 like some are claiming.”
Contributing: The Associated Press
This article originally appeared on USA TODAY: A fight is raging in the stock market: Should you worry about your 401(k)?