In 1929, multimillionaire investor Joe Kennedy, Sr. was having his shoes shined, with the added benefit of receiving generous and unsolicited investment advice from the shoeshine boy. For the future patriarch of the Kennedy political dynasty, the combination of the young boy’s confidence and ignorance was the final sign that investor sentiment had become irrationally exuberant. Kennedy promptly returned to his office, sold his entire stock portfolio and used the proceeds to short the market – that is, bet that stock prices would decline.
Shortly thereafter, an epic market crash ensued, leading to ruins for many, but vast riches for Kennedy. Or so the story goes.
The most obvious sign of the market’s current excesses may be found in the surging shoeshine boy-like confidence of retail investors with virtually zero investment experience. Since the stock market rebound of last year, the number of newly minted investment pundits willing to provide stock tips has rapidly multiplied. Kennedy’s shoeshine stock expert is everywhere, most prominently on social media forums like Reddit.
Reddit speculators have turned stock picking into a large coordination game that has little interest in the actual businesses of the companies they target. Almost 25% of the companies in the Russell 3000 Index do not generate enough earnings to even cover this year’s interest payments on their debt. Yet the stock prices of these 726 so-called “zombie firms” (as in the walking dead) have gained an average of 30% in 2021, more than double the return of the entire index. This zombie basket holds plenty of Reddit favorites.
In the traditional sense, the price of a stock is driven by the value of the stream of cash flows the underlying business delivers to its owners. In the Reddit sense, however, the price of a stock is driven by Ponzi-scheme economics — if everyone will just keep buying, the stock will go up. In this shoeshine/Reddit world, business reality is merely a side-show. It doesn’t matter if a stock is absurdly overvalued; just hop on the roller coaster and get off at the top.
Legendary businessman Sam Zell has a great investment philosophy: If you’ve got low downside and big upside, you do it. If you’ve got big downside and small upside, don’t. Today’s shoeshine investors seem to view this simple equation in reverse. The seduction of quick gains makes it difficult for some investors to ignore the downside risks inherent in these hype stocks. They are playing the investing equivalent of musical chairs, where winners eagerly confuse luck with skill.
These new stock picking experts would be well-advised to remember that investing is not just about building wealth, it is also about not destroying it.
David Moon is president of Moon Capital Management. A version of this piece originally appeared in the USA TODAY NETWORK.