investing · The book

The Psychology of the Meme Stock “Revolution”

A year ago, the concentrated financial power and frustration of millions of novice stock traders rocked Wall Street, alarmed Washington and turned journalists into armchair sociologists. The stranger-than-fiction story sent both publishers and Hollywood studios scrambling to tell it. I’m one of the lucky people who got paid to delve into GameStop mania in the form of a book and I was surprised by much of what I learned.

“The Revolution That Wasn’t” might sound like a “nothing to see here folks” type take, but that couldn’t be further from the truth. Sure the efforts of millions of mostly young speculators to stick it to the man and make a fortune in the process didn’t live up to the breathless headlines of late January 2021. They actually delivered Wall Street and already rich corporate insiders a massive payday. Yet they also showed the awesome power that apps we carry on our smartphones can have over markets.

 I get asked frequently whether another stock will rise from obscurity to become a national obsession again. Probably not quite the way that GameStop did: The crowd’s energy has surged again and again into fruitless attempts to recreate last January’s magic that require “diamond hands” – holding onto crumbling meme stocks no matter what to effect the “mother of all short squeezes,” but professional investors are no longer asleep at the wheel. The more interesting question is why GameStop mania happened in the first place.  I often think of this quote to put things into context:

“We find that whole communities suddenly fix their minds upon one object, and go mad in its pursuit; that millions of people become simultaneously impressed with one delusion, and run after it, till their attention is caught by some new folly more captivating than the first.”

Charles Mackay wrote that passage decades before anybody could describe themselves as a psychologist. He was a journalist, like me, and his classic, “Extraordinary Popular Delusions and the Madness of Crowds,” was published in the midst of Britain’s 1840s Railway Mania. His description of that and other episodes like the South Sea and Mississippi bubbles and Tulip-mania in the preceding centuries are rich with insight into human nature. We have been through numerous manias since then as well – most recently dot-coms and housing. History doesn’t repeat, but it certainly rhymes.

As a long-time investing columnist for The Wall Street Journal and a student of financial history, I still was surprised at some of the new twists to this age-old pattern in the GameStop story. The human psyche hasn’t changed, but Wall Street and Silicon Valley’s understanding of it certainly has. Nobody working at stock brokerages like Robinhood or social media firms like Twitter, TikTok, or Reddit predicted that an informal army of amateurs would blow multi-billion dollar holes in major investment firms for fun and profit. They surely understood, though, that they were pushing psychological buttons that could enrich them at the public’s expense.

Take reinforcement. Since behaviorist B.F. Skinner’s experiments on the variable reward ratio in the 1950s, games of chance such as slot machines and their digital equivalents have been designed to provide stimuli that, for far too many people, lead to addiction. While the stock market isn’t really “a casino,” as some critics contend, the newest generation of smartphone based trading apps borrow heavily from the gambling world to create engagement. Robinhood, which has captured about half of all new brokerage accounts opened in the past five years, has been sued for using animated confetti and giving away free shares of widely ranging value–a lottery-like prize– for opening accounts and referring new customers.

Today it is nearly free and effortless to be an investor by buying and holding diversified index funds and it is becoming common knowledge that even the pros can’t beat those plain vanilla products 80 percent of the time. But index funds are far less profitable for the industry. Instead of having them “set it and forget it,” checking their portfolios occasionally, online brokers have convinced some customers to trade thousands of times a year. Robinhood’s active users check their accounts several times a day.

“You were born an investor,” claim its ads targeted at young people. Their costly level of hyperactivity is in part due to the “illusion of control” described by Ellen Langer’s experiments in which people put an irrational value on personal agency. That is why lottery sales are far higher when people can pick their own numbers despite identical odds. 

Meanwhile, the Dunning-Kruger Effect–the behavioral bias that makes novices overconfident in their abilities–was put on steroids by the pandemic. The wave of new account openings coincided with both the arrival of pandemic stimulus checks and the quickest rebound ever from a bear market in 2020. In a trend never seen before, 96 percent of stocks would rise in the ensuing year, making investing look easy. Dave “Day Trader” Portnoy, himself a newbie who boasted that he was better than 91 year-old legend Warren Buffett, would livestream himself picking tiles out of a Scrabble bag to choose stocks to his huge social media audience. Success, as they say, is the worst teacher.

And when they opened the app, Robinhood and its many imitators showed them the day’s most active stocks for a reason–to stoke the fear of missing out. Studies have tied acting on FOMO to feelings of regret. When the newest speculators buy too late or sell too early to make a score, they are encouraged to keep trying, as exploited by gambling establishments through the near miss effect (like when a slot machine displays two of three cherries or the ball in roulette falls one slot away from giving you that big payoff).

Of course so many people with so little money turning themselves into a major force in the market wouldn’t have been possible a generation ago. Trading stocks has become progressively cheaper. Robinhood was the first successful broker to charge nothing for a trade, though.

Trading isn’t really free–huge market makers gladly pay brokers to fill their customers’ orders–but the fact that small investors who have never paid a commission in their lives perceive it as costing nothing has triggered the “zero-price effect” described by behavioral finance experts. Demand normally rises when prices fall. The formula goes haywire, though, once prices hit nothing for something that also entertains us. Trading stocks for “free” has been made so much like a game that retail activity has exploded. 

This shift to zero at every major broker happened just in time for the pandemic, which supercharged locked-down and bored young people’s speculative tendencies. And because they got “house money” via stimulus checks, investors’ sometimes crippling fear of financial loss as described by Prospect Theory was short-circuited at a critical time. Millions opened accounts, many of whom had already dabbled in recently-legalized sports betting, and they found they liked stocks even more. The sharp market rebound from the initial pandemic plunge created unprecedented volatility and excitement. And brokerages’ irresponsibility in allowing newbies to trade complex stock options, with their asymmetric payoffs and finite time horizon, made investing resemble sports betting.

But what to buy? Young Americans’ love of social media meant that it was “finfluencers” like Portnoy rather than Mom and Dad’s broker at Morgan Stanley who provided ideas. The most influential voices were the most confident and often the wildest. And it was those stocks that did best for a while, reinforcing the wisdom of following the crowd. The top 100 stocks highlighted by Robinhood on its app rose by 102 percent in 2020 according to an index created by newsletter writer Noah Weidner–some six times as much as the benchmark S&P 500. Baskets of companies with no profits or those heavily shorted by skeptics also had a great year.

And, because Millennials and Gen Z share private information online so readily, those bragging about big scores on those stocks often backed it up with screenshots of their brokerage accounts. This triggered a phenomenon called social proof in which apparently successful people, even if they were just lucky, gained undue influence.

Virality was instrumental in the runaway popularity of small, money-losing companies. On Reddit’s r/wallstreetbets in particular, which would become the epicenter of the GameStop squeeze, reckless wagers in crowd favorites were the most likely to become “upvoted” and hence visible to somebody logging on. The wave of buying would become self-reinforcing and the support of certain stocks has become tribal and almost cult-like for some who dub themselves “apes” and who subscribe to conspiracy theories involving nefarious hedge funds and even journalists like me.

As of this writing, the thrill of overnight fortunes made and lost last year hasn’t faded for many trading novices. With the exception of those who are turning meme stocks into an obsession, though, the spell will break eventually. As Mackay sagely wrote 180 years ago: 

“Men, it has been well said, think in herds; it will be seen that they go mad in herds, while they only recover their senses slowly, one by one.”

(This post originally appeared on LinkedIn)

Book reviews · The book

LA Times and The Economist Reviews!

My first impression of a person who reviews others’ work for a living came at age 12 from watching the Mel Brooks film History of the World Part One where we’re introduced to Ugg, the world’s first artist, and then the world’s first art critic. He delivers a scathing verdict on Ugg’s cave painting without saying or writing a word.

I am very happy to report that neither of the two fine publications, The Los Angeles Times nor The Economist, that have so far reviewed my book peed on it. This is what the LA Times had to say:

Jakab is a former investment banker who currently writes the Wall Street Journal’s “Heard on the Street” column; he knows what he’s talking about. He’s skilled at translating concepts like puts and calls and short sales and gamma squeezes into language most anyone can understand — a true gift.

LA Times

And later in the review:

Like so much reporting in recent years, Jakab’s book is both depressing and necessary … Anybody who buys and sells stocks, and anyone who “invests” in anything old or new, should read this book.

LA Times

Now that’s nice. And The Economist, which I have been reading for 30 years now, came through with a really flattering take too.

Spencer Jakab, a columnist at the Wall Street Journal, unknots the threads of this complex financial tale. His is a pacey and comprehensive account that takes in the structural changes in finance and the media that made the turmoil possible. 

The Economist

And lower down

…Mr Jakab’s knowledge of Wall Street shines in the historical context he provides and the industry aphorisms he relays (the retail investors who can lose out when hedge funds prosper are typecast as “a lot of dentists”). Despite the density of the subject matter, which includes “rehypothecation” and “gamma squeezes”, the story is deftly told. If the first draft of history was not quite on the money, as Mr Jakab contends, his second go has set the record straight.

The Economist

Please check out the book.

Columns · investing · The book

Wall Street Journal book excerpt

(L-R) Bill Gross, Ken Griffin, Jason Mudrick, Vlad Tenev and Baiju Bhatt SIUNG TJIA/WSJ

Today’s Wall Street Journal has a 1,500 word excerpt of one of the chapters in my book. The article’s title is “Who Really Got Rich from the GameStop Revolution?” One helpful reader has already written to complain that they had to read too far into the article to find out. When I answer a WSJ subscriber (and I always do, unless they’re menacing or insulting), I try to be courteous. Still, the huge photo of five billionaires behind the article’s title was a pretty good hint, I think.

Anyway, the excerpt is an interesting part of the story but one of the less-surprising things you’ll learn if you read the book. Far more interesting to me was how trading and social media apps are so effective at getting people to act recklessly. The human psyche changes very slowly, but companies’ understanding of how to push our psychological buttons has evolved as quickly as the technology they can bring to bear. I’ve been working in or writing about financial markets for 29 years and I learned a lot while doing my research. You don’t have to be especially interested in finance for this to change the way you see things.

The book’s U.S. release is Tuesday, February 1st, available for pre-order now!

investing · journalism

On CNBC for GameStop Mania Anniversary

I spoke about the book (out in a week!!!!) with CNBC this morning. I’m no natural on TV and always a bit nervous about condensing the insights of a whole column, much less a 320 page book, into a series of soundbites. But I think Andrew Ross Sorkin’s questions were sharp and my answers were acceptably concise. Check it out:

Columns · The book

Robinhood Traders Robbed Themselves

You might have noticed that the stock market is a tad wobbly these days. Your own portfolio might be significantly wobblier than the headline numbers suggest if you piled into some of the most popular stocks on social media, so I hope you didn’t.

A lot of those same stocks happen to be in the top 20 or top 100 on Robinhood which, for anybody who reads my book (out on February 1st), won’t come as a surprise. This herd-following behavior was in fact pretty profitable for a while. I wrote about the downside of that today.

A clever young man, Noah Weidner, kept track of an index of the most popular stocks owned by investors at the broker. More recently, even after the data feed was curtailed by the broker, he kept up a list of which stocks entered and exited the top 100. For the most part those rejected like energy ETFs, Berkshire Hathaway and Wells Fargo went on to do well. Meanwhile, most of those added have been among the biggest losers recently, including shares of Robinhood itself. I link to an academic study that does a nifty job of explaining why that happened.

Stay safe out there.

investing · The book

With the Mulligans on Full-D Radio

Full D Radio

I had the pleasure of being interviewed about the upcoming book by veteran financial journalist Roben Farzad on Full Disclosure Radio, which airs on NPR stations and is available as a podcast. This was a double treat because Roben is so well-prepared and also because he also interviewed two young men, Quinn and Finley Mulligan, for the same segment.

I spoke with a lot of smart people for the book, ranging from experts on options trading to social psychology to short selling to problem gambling to marketing to behavioral finance to Silicon Valley’s culture, but people like Quinn and Finley are really the subject of the book and their insight was tremendously valuable. They are among the “apes” who bought and continue to buy GameStop, AMC and other meme stocks either as a way of making money, sending a message, or both. While I don’t personally recommend doing that, their explanation in the podcast of why they and others continue to is smart and worth a listen. And they aren’t just any apes – the twin brothers are in the process of making a documentary about it, Apes Together Strong.

The rise of the apes and the rush of young investors into stock and crypto trading is the biggest personal finance story, if not financial story period, of the past few years. I knew I had to write about it as soon as one of my sons pointed me to what was happening on r/wallstreetbets a year ago. The episode blew multi-billion dollar holes in some of the slickest hedge funds on Wall Street. But it also poured billions more into the coffers of other Wall Street establishments who claim to be “democratizing finance” and continues to do so.

I hope you’ll check out the podcast, the upcoming documentary and, of course, my book.

Columns · investing · The book

Does Your Index Fund Have “Diamond Hands?”

Yes, these are Roaring Kitty’s hands

Anybody who has read my first book knows that I take a mostly dim view of active management. Still, this week I wrote about an episode central to my upcoming book that proves an exception: how active managers handled meme stocks.

When the market values of GameStop, and AMC went up several hundred or thousand percent based on no change in their fundamental value, active fund managers did the obvious thing – they dumped them and moved on. But index funds, which tend to beat those active managers in the long run, held tight with “diamond hands” because they have to. In some cases they bought more at inflated valuations as their assets grew or as those companies issued shares to their now almost entirely retail base of owners. The only passive investor I’m aware of that was able to take the money and run was Dimensional Fund Advisors (I interviewed their deputy head of portfolio management, Mary Phillips, for the column). Even today, with their share prices (in my opinion) still grossly elevated, the main owners of the meme stocks are the self-described “apes,” many of whom believe there is still a short squeeze looming because of phantom shares.

Active fund managers shouldn’t look a gift primate in the mouth. The last year that funds benchmarked to the Morningstar Large Blend category outperformed that benchmark was in 2013 and before that it was 2009, according to a study by Hartford Funds. Index funds have strung together several consecutive winning years over their active counterparts during extended bull markets in the past, too—for example between 1994 and 1999.

This is one of those cases when owning an index fund can be frustrating. As of today, the top two holdings in the Russell 2000 Value Index – let me repeat, “value” – are AMC and Avis Budget Group, another company that recently got the meme treatment for discussing the addition of electric vehicles to its fleet. Whatever.