The 1991 Perfect Storm, the storm made famous by the book and movie of the same name, was a nor’easter that absorbed the remnants of Hurricane Grace and ultimately evolved into a hurricane in its own right. Wave heights reached as high as 100 feet with winds as high as 70 mph at the peak of the storm. The hurricane was never named but was later referred to as “the Perfect Storm.”
Damage from the Perfect Storm was heaviest in Massachusetts where the fishing vessel Andrea Gail was based, which sank in the middle of the storm, killing all six crew members on board – inspiring the book, and later a movie starring George Clooney and Mark Wahlberg, The Perfect Storm.
Thirty years after the Perfect Storm, another perfect storm is brewing, but this time on Wall Street. A storm of speculation is expected to hit Wall Street in the very near future from the collision of three factors: 1) free trading, 2) low-interest rates, and 3) stimulus checks.
The rise of startup online trading platform Robinhood, which offers commission-free trading, has played a huge role in the rise of young and inexperienced traders taking to stocks for the first time – treating Wall Street like Las Vegas. Bored from the lockdown world of the pandemic, these newbie day traders embraced the thrill of speculation. This contributed in no small part to rabid demand for stocks and the resulting sharp rise in stock prices – even for stocks of underlying companies like Hertz which had filed for bankruptcy in the wake of the pandemic.
The low-interest-rate environment is also fueling fevered speculation because low-interest rates reduce the cost of risk-taking. Investors can shrug off investment losses by taking out low-interest loans or using credit cards to compensate for any financial setbacks.
The last piece of the puzzle before the next storm of speculation hits is stimulus checks. We got a glimpse last March and even as recently as January of what we can expect when the third round of stimulus checks hits. After the first round of stimulus checks at the end of March and early April of last year, a huge surge of novice day traders flocked to Robinhood and other trading platforms.
These traders became more sophisticated – but no less speculative – by the time the second round of stimulus checks hit at the beginning of January. The timing of the giant short squeezes in stocks including GameStop fueled by day traders collaborating on Reddit is no coincidence. Robinhood’s liberal margin policies have also fueled the fevered trading and speculation by allowing investors to buy stocks at multiples of four or five times their cash balance on borrowed funds.
What will the perfect storm of speculation mean for the mainstream investor? It will mean extreme volatility in the best case scenario and a market crash in the worst case once the market corrects itself from extreme overvaluation.
Speaking of volatility and overvaluation, you only have to look at Gamestop (GME) to get a glimpse of what’s going on in the broader market. GME stock started the year around $17.25. Fueled by the whole short squeeze play by Reddit users, it surged to an intraday high of $469.42 on January 28th. After Robinhood stepped in to ban further buying of GME stock to save the hedge funds who had already lost more than $13 billion, GME stock came crashing back down. As of this writing, the price is currently around $49.
With declining sales due to the pandemic adversely impacting brick and mortar retailers like Gamestop, there is no economic justification for GME trading at $49 – let alone $469.42. Gamestop reported $1.28 earnings per share for the fourth quarter of 2020. At a price of $49, it is trading at a price to earnings (P/E) ratio of 38. The average historical P/E ratio of all stocks is around 16. GME stock like many other stocks on Wall Street is overvalued and it’s only a matter of time before a correction hits.
Seizing on this perfect storm of speculation, companies across multiple industries and segments will reach out to investors who are sick of the volatility fatigue. As the economy reopens due to the accelerated rollout of the COVID-19 vaccines, there will be a flurry of business, travel, and social activity across the country. GDP and employment are both expected to make significant gains in 2021.
There will be no shortage of investment opportunities as the country gets back to work this year. Companies and entrepreneurs who will seize on these surging economic opportunities will reach out to those investors seeking an alternative to Wall Street – leery of the impending implosion. The perfect storm of speculation on Wall Street translates to the perfect opportunity to turn to alternatives that offer above-market returns but at reduced risk – insulated from Wall Street speculation and volatility.