Is the Stock Market in for a 2021 Correction? Or Has It Just Grown Bigger?
Updated: Oct 8, 2021
When your average person talks about the stock market, they like to use aphorisms, little phrases like “What goes up must come down” or “Buy low, sell high.” It's not true across the board, of course, but it's been consistent in my experience.
These descriptions of the market are popular because they’re simple and generally reliable. They make sense on a gut level. However, they're problematic because they're only true in hindsight. A market only hits a high after its followed by a drop. Otherwise, the current high is just a leg up to another point of resistance. No serious investor will recommend trying to time market highs and lows. The data doesn't support that short-term, in-and-out strategy. You'll have better luck letting an investment grow over five to 10 years. In short, investing strategies are forward-looking while stock market witticisms are backward-looking.
Since these aphorisms aren't actually helpful in making money, why do we hold on to them? I would argue that these simplifications provide emotional hedging against a stock market that is beyond the scope of the human mind and fraught with potential dangers. Common wisdom advises investors to trade without emotion. Of course, it's not a good idea to put your whole retirement in a stock just because a Twitter furu uses a couple rocket emojis next to an unknown ticker. This is obvious emotional trading. Emotional trading that's far less examined happens when emotions force traders to remain too conservative or not take any action at all.
For example, simplifying the stock market to some “Red at night, sailor’s delight” maxim provides a false sense of comfort. If I just buy low and sell high, I'll be OK. But this is analogous to someone who believes Newton’s three laws can account for the entire field of physics. It's too simple and causes more harm than good. As I've already explained, this thinking is counter productive and relies on timing the market, which leads to emotional trading to dictate entry and exit points.
Another phrase I often hear is, “Investing in stocks is just like going to the casino.” To me, this phrase is a hedge against a hurt ego. It's not rooted in reality. Casinos don't provide an average 8% annual return. But the phrase does protect against feelings of fear and insecurity. Many people have lost life savings in stocks, and so dismissing the market entirely protects someone from financial risk and the potential for failure. Dismissing the stock market also provides the cagey potential for a smug “I told you so,” whenever the market dips.
I’m not claiming to understand the stock market. But I have been investing for over 10 years and I believe that the best course of action is to learn as much as you can and be honest about what you don’t know. I take issue with people who dillydally on the sidelines using stock phrases to make simplistic predictions and shield themselves from risk.
Why? Because I’ve lost out on quite a bit of money listening to these people.
One day long ago, my high school philosophy professor drew a big triangle on the classroom white board, a tall, pointy, scary-looking triangle. This was right after the 2008 economic collapse. Every day on the way to school, I heard radio snippets saying, “DOW dropped 300 points” and “A global financial collapse is upon us.” In the months that followed, we would begin to understand the warning signs nobody heeded: housing prices had skyrocketed, lenders were over-leveraged, bad debt was being repackaged and sold, energy prices were through the roof, and even the Baltic Dry Index showed that international trade was running on overdrive.
But back to the triangle. The triangle was meant to represent the stock market. It went up and then it went down. Did we see how it went up so high? Much higher than previous boom and bust cycles? If I remember correctly, my teacher blamed government subsidies and stimulus initiatives. Of course, this philosophy professor – note, not an economics teacher – didn’t point to any other economic trend lines like I mentioned before. Nothing about bad mortgages, debt burdens, or sector indices. Rather, all he said was, “What goes up must come down” peppered in with a little libertarian lingo. He told us that if we were wise, we should all be very careful because if the stock market regains its pre-2008 highs, the next crash will be even worse.
That “lesson” stuck with me. I began trading as a senior in high school. I opened my own Scottrade account (before it was bought by TD Ameritrade). The market was flush with opportunities right after 2008, and I wanted to make some money. But rather than investing my summer job earnings into up-and-coming companies like Netflix, Tesla, and Amazon; I stuck with the most traditional, old man company I could find: General Electric.
I thought General Electric would hedge against a market downturn. I trusted my gut, which wasn't my gut, but an unexamined emotional tie to authority. I needed to listen to my superiors and be a "good boy." In this case, it meant trading stocks conservatively.
But General Electric had seen better days. The stock stayed more or less even for four years. And if I had held those other companies for 10 years, I could have bought a house in cash and then some.
Is the Stock Market On the Brink of Collapse?
Recently, internet buzz has been growing around the timing of the next market collapse. What will knock down the first domino? Investor confidence is dwindling as more and more finance experts recommend a conservative short-term equity strategy. It's true that the global economy doesn’t seem to be particularly stable given the recent Evergrande collapse, rampant inflation, and memestock hedge fund scares. But the point of this article isn’t to predict any market movement up or down. Rather, it’s meant to explore a specific psychology people hold toward the stock market.
Most individual retail investors might not be aware of the various factors affecting the market. Surveys show that six out of 10 Americans read only headlines and nothing more.
If you find yourself reading headlines and thinking, "The stock market is way up. It's time to pull out," first congratulate yourself on reading this article. You're in the minority of readers. Second, you may be operating from emotional defensiveness and you may miss out on investment opportunities. That's because there are reasons that suggest the stock market has added long-term, stable volume that isn't based on false accounting and smoke and mirrors.
Over the past two years, the stock market has been on a significant bull run. That's true. The S&P 500 has nearly doubled since the shutdowns in March of 2020. This has far outpaced traditional stock market returns over the past 70 years.
However, I refuse to believe that a crash is inevitable just because the numbers keep getting bigger. I’m all ears when it comes to arguments against debt-ridden central governments and how supply chain issues will decimate the labor force in the next six months, but it’s time to give up on oversimplifications based on fear.
Before jumping to conclusions, we have to first ask, “Why is the stock market so high?” If the stock market is high because people are taking out personal loans in order to play meme stock swings, then perhaps it’s time to sell – that's a house of cards waiting to crumble – but if the stock market is high simply because of increased total volume, then there’s little reason to panic. I believe the second scenario is more likely.
The Rise of Robinhood and the Retail Investor
Robinhood, the company behind the popular zero-commission trading app debuted as a public company on the NASDAQ July 29, 2021. It raised around $2 billion through its IPO. Small companies do not debut on the NASDAQ. Large, high-growth companies trade on the NASDAQ. Over the last five years, Robinhood has emerged as a household name in equities and finance.
The company has taken off over the past two years as new users flock to the platform. According to statistics by Business of Apps, “Robinhood generated $682 million in payment-for-order-flow revenue in 2020, a 514 percent increase year-on-year.”
The New York Times also ran a feature on Robinhood that included two impressive metrics:
In May 2020, the number of Robinhood accounts reached 13 million, up from 10 million at the end of 2019.
Robinhood reached three million funded accounts in the first four months of 2020. Its three most active trading days of all time came in June, 2020.
What does this mean for the value of the stock market as a whole? It means that more people are moving their money from other assets into equity. As technology increases access to the stock market, the stock market will account for a larger portion of the country’s total economic pie. Fifty years ago, a day trader would have to call a broker and make trades over the phone. Now that process has been streamlined to the push of a few buttons. More people are able to invest in the stock market, and so it makes sense that the increase in cash flow would boost the total value of stocks.
Stock Are Becoming a Bigger Piece of the Pie
According to Brookings, “In 2018, U.S. households held over $113 trillion in assets. For context, that is over five times as much as all the goods and services produced in the U.S. economy in a single year.”
These assets are distributed among cash, stocks, bonds, real estate, vehicles, etc. We’re seeing that stocks are becoming more popular as an asset class. Market research for 2021 shows this to be the case:
Federal Reserve Board data showed the value of U.S households’ liquid assets increased by 16.7% to $58.5 trillion in 2020 from $50.2 trillion in 2019. Of total liquid assets held by U.S. households, 44.2% was in equities, 23.4% in bank deposits and CDs and 19.2% in mutual funds, with the remaining 13.2% split between U.S. Treasury securities; agency & GSE securities; municipal bonds; money market funds; and corporate bonds.
Parsing the math, we can see that from 2019 to 2020, an additional $4 trillion (44.2% of $8.3 trillion) was added to stocks and related equity investments. By the end of 2020, the estimated total market cap of the US stock market was $40 trillion. These numbers suggest that around 10% of stock market gains in 2020 were related to new investors entering the market, not just naked speculation by existing investors. Even if the market is a bit overbought, a pullback isn’t likely to crash prices to pre-2020 levels since its unlikely these new investors will pull every one of their investments and refuse to reenter the market once prices dip.
Let’s also not forget there are other potential reasons for the recent increase in equity valuations. These might include:
Lack of household spending options during the pandemic shutdowns. Vacation and leisure spending decreased in 2020. We saw significant increases in home prices and equities as that money was reallocated to places where the money could be spent.
Other savings options are worthless. CDs and bonds provide meager returns compared to stocks. However, the Fed recently raised bond yields, which caused a pullback in stocks, signaling that investors may choose safer options if they become available.
Publicly traded companies took market share from smaller, non-public companies. A Washington Post article reads, “A Post analysis found 45 of the 50 biggest U.S. companies turned a profit since March. The majority of firms cut staff and gave the bulk of profits to shareholders.” The recent rise in stock prices may be a simple swap in value. As small businesses closed down during the pandemic, larger companies profited off the increased customer base and lower competition.
Are stocks out of the woods?
My analysis suggests that the current stock market isn’t a fragile bubble at risk of popping at any time. As long as current conditions stay the same, we may see strong support around current price levels. Of course, this statement is conditional and reliant on many complex factors including:
Retail investors traditionally engage in more volatile and speculative trading, which could cause uncertainty in the markets
Nation-state debt levels could become unsustainable
Supply chains don’t improve, thus halting work and wages across industries
The what-if game can go on forever. These four bullet points do not encompass every current threat to the stock market. In fact, investments will always carry some level of risk because they’re always fraught with the unknown. But again, I’m not a financial advisor and I’m not recommending any investment actions based on this article.
Instead, I encourage readers to be aware of the tendency to use gut reactions to oversimplify situations and miss out on potential opportunities. Remember to check in with your emotions when you trade. Short aphorisms are often thinly veiled emotional defense mechanisms.
Behind the saying, “What goes up must come down,” is the belief that I don’t deserve good things. The other shoe will drop at some point, the question is when. Or from another perspective, that person who just made $100 k in the stock market is probably going to lose it soon. Why do they deserve more success than me? The ups and downs of success are just a rule of the universe.
Of course, no such universal rule exists.
The saying, “The stock market is just like gambling,” is often a defense against fear or insecurity. If gambling is irresponsible, and I equate the stock market with gambling, then I’m justified in sitting on the sidelines and avoiding risk. Some people feel insecure when confronted with particularly complex and opaque concepts. They oversimplify the concept so that they feel in control and can make snarky comments to deflect from the fact they don’t understand the stock market.
I see oversimplification used as a defense mechanism in all areas of life. Conversations about religion, politics, healthcare, etc. easily devolve into rote phrases that don’t address the true complexity of the problem. Rarely do we ask, “Why is this happening?” Even more rarely do we say, “I’ve reached the point where I can’t try to explain this phenomenon any further.”
When it comes to investing, I believe in learning as much as I can about a stock and then hedging against everything that remains unknown. Traders always say do your due diligence. But due diligence has as much to do with material facts as it has to do with the unknown. The stock market is not an all or nothing concept. It's not divided between those who understand it and those who don't. Rather, it's about the degree of understanding. Grasping 55% of a stock setup vs 45% can be the difference between gaining or losing thousands of dollars. The same goes for God, raising children, and the political mechanisms of the United States. These aren't things we can "understand" like a multiplication table. These are things that require a lifetime of study just to scratch the surface.
When in doubt, remain in doubt. Check your emotions. Do research. Don't write off a complex situation with cheap maxims. Otherwise, you risk investing in a GE when you could have had an Amazon at $120 a share.