The stock market of the past two years has been strange. Very strange.
During the pandemic, equity markets were invaded by Reddit traders and YouTube influencers who collectively picked meme stocks to “send to the moon.” The use of free trading platforms, like Robinhood, brought tens of thousands of armchair Bud Foxes into the fold. Companies that told a fancy story about future growth saw their stocks soar as bullish investors rolled their eyes at traditional metrics for valuing companies and bought promises, not profits.
But if all goes right in 2022, that will change. COVID-19’s stranglehold will loosen, (some) workers will return to their offices, and interest rates will rise as the world’s central banks try to cool down economies heating up with activity. These conditions are ripe for Wall Street’s biggest players — with all their stuffiness and number crunching — to strike back. Amateurs beware.
The era of the meme trader
The stock market is a game of perception in which participants collectively craft a story about what has value. Wall Street has been playing it fast and loose with the concept of value since the financial crisis, increasingly selling unbelievable stories that have resulted in epic failures (see: WeWork). But during the pandemic, these institutional powers lost control of the narrative. Retail traders piled into the market, and traditional metrics for determining value got thrown for a loop.
Recall March 2020. We were trapped in our homes, wiping down groceries and slowly watching case numbers rise. To distract from the horrors around us, we turned to the digital world for entertainment and companionship. Amid the “word of mouth” tips.parties and watch-alongs, thousands of people, skeptical of old-guard financial institutions and desperate for financial security, found online communities that promised to get them rich with
No-fee trading apps like Robinhood made it easy for these new stock gurus to jump in. The number of trades happening on the six-year-old platform started lapping older brokerages that had been in the business for decades. In the first quarter of 2020, Robinhood users traded nine times as many shares as E-Trade customers did and 40 times as many shares as Charles Schwab customers did. In June 2020, Robinhood users averaged 4.3 million revenue trades a day, the highest of the online brokerages.
The low barriers to entry made it easy for people to join the fun, but it was the message that sold people. Bored amateurs with nothing else to spend their money on portrayed themselves as righteous crusaders determined to tilt the scales of capitalism back toward the everyman. “Populist” billionaires like the venture capitalist Chamath Palihapitiya drew in retail investors by promising that they were on the “little guy’s” side. Social media was awash with amateur prophets and “apes” railing against the “big guys” and promising to identify the next big winner.
When the investing legends Warren Buffett and Charlie Munger panned Robinhood as a gambling parlor, this new guard of traders took it as an attack on their whole ethos.
“If the last year has taught us anything, it is that people are tired of the Warren Buffetts and Charlie Mungers of the world acting like they are the only oracles of investing. And at Robinhood, we’re not going to sit back while they disparage everyday people for taking control of their financial lives,” Jacqueline Ortiz Ramsay, Robinhood’s head of public policy communications, wrote in a company blog post.
The meme chasing, the amateur stock jockeying, the “to the moon” optimism is all classic stock-market bubble behavior. And as much as financial professionals love to deride bubbles in the stock market, they can’t stop themselves from trying to profit from one. So once the stock-market game changed, Wall Street adapted, and man was it weird.
It even infected Wall Street
Wall Street hedge-fund conferences are staid affairs, but this year’s SALT (short for SkyBridge Alternatives) conference was different. It usually features a lot of similar-looking people in similar-looking clothes with similar-looking haircuts talking about monetary policy, asset allocation, and portfolio construction. Sometimes a dad-rock band, like Kings of Leon, performs. There are parties, but no one dances — and for the sake of decency, no one should.
But at this year’s edition, held in September, normality was swept aside. Instead of hiring a sensible dad-rock band, someone decided that The Chainsmokers should perform. There was no “best stock-pick idea” panel, and the hedge-fund superstars who spoke could only marvel at the market’s behavior. “Lets see what it looks like when the world changes” was the most insight that Steve Cohen, the billionaire hedge-fund manager and New York Mets owner, could offer at a talk optimistically entitled “The Hedge Fund Comeback.”
Weirdest of all, about a third of the agenda focused on crypto — a world that just a few years ago could not be discussed in polite Wall Street conversation. The crypto people, clad in sneakers and T-shirts, noticeably clashed with the business-casual hedge-fund crowd.
Traditionally, the closing speech at a hedge-fund conference is taken by the previous year’s biggest swinging dick. In 2021, that BSD was Cathie Wood of Ark Invest.
Arguably no investment firm has leveraged the power of social media like Ark Invest. Ark hands out research for free, posts its trades daily, and sells great stories. Instead of dismissing the “apes” of Reddit and the hordes of Robinhood investors, Wood and Ark actively court them. In a world that seems more uncertain than ever, Wood and her firm sell a concrete vision based on retail renegades’ favorite types of investments: crypto, futuristic but dubious tech companies, and companies that provide solutions to seemingly intractable problems.
In her speech at SALT, Wood said she’d been amazed by retail investors’ hunger for knowledge. “Their gratitude has been extremely humbling,” she said. “People come up to us and thank us because we’ve opened their eyes to a new world.” Retail investors call her Mama Cathie or Aunt Cathie. They like Ark’s transparency, and their trust in Wood can border on blind faith.
I cannot stress enough how odd it is for a money manager with Wood’s connection to retail investors to take prime time at SALT. Wall Street is still a place very much about pedigree, but over the past few years retail investors have shown that they can be powerful allies, shaping the market in ways finance’s Brahmins have never seen before.
There are signs, though, that this alliance is already fracturing. After dominating in 2020, Wood’s Innovation ETF fell by 26% in 2021. This summer, Robinhood told investors that the less volatile market to come could turn its platform into a so-called ghost town. In the third quarter, the company made $65 in revenue from each user, down from $112 in the previous quarter and $102 in the previous year. It would be kind to call this a slowdown; it is more akin to a face-plant — and a sign of things to come.
It’s time for Wall Street to strike back
The shape of the stock market’s COVID-19 rally has been good for optimistic trend followers. Because interest rates are so low, it is cheap for companies to borrow money, manage their existing debt, and keep things going despite underlying problems. It’s the kind of environment where every company looks good enough, profits don’t matter, and investors want growth above all else.
That kind of market means the old rulebook for finding solid investments — undervalued companies, well-run companies, profitable companies — went out the window, leaving Wall Street’s old guard out in the cold. In a letter to investors in October, David Einhorn, the famed investor and founder of Greenlight Capital, lamented losing money after investing in strong companies that beat Wall Street’s earnings expectations but got no love or attention from the meme stock mania. “It’s not that the stocks are hated; it’s that it’s apathetic. There’s nobody actually listening,” he said in an interview cited in the letter. “There’s nobody on the call. There’s nobody performing analysis.”
But the backdrop that made it so ripe for retail traders to ride the market and prodded Wall Street into a herd is changing. In what is perhaps a symbol of Wall Street’s intransigence, the one to put an end to the market’s Reddit revolution is a 68-year-old former private-equity partner and currentchairman: Jerome Powell.
Powell, who in the past two years has been a hero to Reddit’s renegade WallStreetBets community (they call him “Daddy Powell”), has signaled that the Fed is planning to cut off some of the central bank’s support for the economy and potentially raise interest rates in 2022. This creates the perfect situation for Wall Street’s stock pickers. Rising interest rates complicates the picture for growth companies. As rates rise, it becomes more expensive for companies to pay down or take on new debt, things like balance sheets and profits matter again, and companies can’t just rely on promises and stories about the future. And in a world of winners and losers, where how well a company is run matters more than what it promises, investors will have to become more discerning again — that’s a game for professionals.
In their year-end outlooks, strategists across Wall Street are telling their clients to be patient because even with a strong economy. They’re warning that it’s going to be a little harder to make money and just betting on a rising tide may not be a smart strategy. “However,” as Michael Wilson over at Morgan Stanley put it, “strong nominal GDP growth should continue to provide plenty of good investment opportunities at the stock level for active managers.” In other words, there’s money to be made — but it won’t be as easy to find. Or as one of Wilson’s colleagues at Morgan Stanley, Lisa Shalett, said in her note: “investors should move toward stock picking and away from passive index funds.”
There are other quantitative signs that the COVID-19 fever that gripped the stock market is abating. As meme stocks like AMC and GameStop have fallen, short sellers have been making gains again. Crypto has been getting smoked. The SPACs helmed by celebrities and professional athletes hoping to attract retail investors are getting crushed. CEOs and founders, like Tesla’s Elon Musk, are selling their own companies’ stocks at record rates. One sentiment indicator suggested that day traders were much less optimistic about the market than they had been.
The most entertaining sign that Wall Street is prepared to strike back, though, is qualitative: it tells us that the “masters of the universe” seem ready to take back their seat as the BSDs of the investment universe.
This fall, Sotheby’s auctioned off an original copy of the US Constitution, and a 17,000-person consortium of gung-ho crypto investors crowdfunded $40 million to buy the document and give it “back to the people.” It was supposed to be a sign of crypto’s new economic importance and its populist underpinnings.
But then the Citadel founder Ken Griffin, a longtime villain for the Wallstreetbets and crypto crowd, got wind of the movement. So Griffin bought the copy of the Constitution instead — for $43 million. He told Crain’s Chicago that he tried to cut a deal with the consortium for some kind of ownership-sharing thing, but it didn’t work. Too bad.
Needless to say, the consortium was upset. Michael Novogratz, the founder of the crypto shop Galaxy Digital Holdings, said Griffin was a “Grinch” who ruined what “might have been the coolest thing that happened all year long in crypto.” Griffin, for his part, plans to display the Constitution at the Crystal Bridges Museum of American Art in Bentonville, Arkansas — not a place known for its crypto scene. The whole story is so Wall Street that all I can do is laugh. It’s the stuff of Michael Lewis’ dreams.
What Griffin did was remind the consortium that its collective efforts were no match for someone who has mastered the machinery of finance. The members may, from time to time, be able to organize themselves into a force powerful enough to move the market — or make a bid for the Constitution — but can they sustain it? Because, if not, Wall Street will always be waiting, armed to the teeth with a pile of money, ready to reclaim its turf.