IN HER MOST RECENT book, former Secretary of State Madeleine Albright quotes Mussolini. “If you pluck a chicken one feather at a time,” he said, “no one will notice.”
Don’t worry, I’m not veering into political commentary. But when I heard this quote, it brought to mind what we’ve been seeing in the financial markets this year. Taken individually, there’s nothing that strikes me as a clear red flag. But taken together, the current environment looks a little bit like a chicken that—all of a sudden—seems to have lost a whole lot of feathers.
Worry No. 1: Market concentration. There are thousands of companies listed on U.S. exchanges. But recently, the largest stocks by market value have grown disproportionately larger. Today, just five stocks—Microsoft, Apple, Amazon, Alphabet (parent of Google) and Facebook—account for more than 20% of the total value of the S&P 500. The percentage accounted for by the largest five stocks has doubled over the past five years.
Why does this concern me? Isn’t that concentration just a reflection of those companies’ success? Yes and no.
Yes, these companies’ earnings have increased dramatically. But as a group, their valuations have increased even faster. That means that investors are paying more for each dollar of earnings. Call me a stick in the mud, but popularity is not healthy for investment markets. That’s what leads to bubbles.
Even if these stocks weren’t becoming more popular—that is, even if their earnings fully justified their share prices—there’s still a risk in this growing concentration. More of the market’s fate now rests on fewer companies, plus these companies are all, more or less, in the same industry, which further magnifies that risk.
While these stocks have been going up, we’ve all benefited. But if one or more of them should hit a speed bump, it will be felt by everyone, like a gorilla jumping in the kiddie pool.
Worry No. 2: Market speculation. Above, I noted the growing popularity of a small group of stocks. The reality is that stock markets, practically since their inception, have walked a fine line between investing and gambling. Three hundred years ago, we had the South Sea bubble—and there have been many more since.
Both investors and brokers play their part in this. Since industry deregulation in the 1970s, brokers have gotten more creative with their advertising, as they seek to draw in new investors. Recall, for example, eTrade’s talking baby and dancing monkey commercials.
Over the past year, the brokerage industry has taken things to a new level. You may have heard of an online trading platform called Robinhood. With an altruistic name, its website states, “We’re on a mission to democratize finance for all.” On the surface, that’s what it’s doing. To open a Robinhood account, there are no minimums and trades are commission-free. It also pioneered the concept of fractional shares, so an investor with as little as $1 can invest in the stock market.
In theory, Robinhood is a good thing. That’s what I thought at first. But Robinhood seems to be appealing more to speculators, or even gamblers, than to investors. As one observer put it, Robinhood’s website makes investing “feel more like playing Donkey Kong than risking hard-earned money.”
When I visited its website, I was offered a free share of stock as an enticement. “When you sign up, a surprise stock appears in your account.” The prospective stocks were presented in the form of animated playing cards, with my odds of receiving each listed alongside. After a user completes a trade, confetti cover the screen. It feels like a cross between a video game and a casino.
It isn’t just the Donkey Kong aspect of Robinhood that’s troubling. By itself, there’s nothing wrong with an engaging user interface. The problem is, there’s evidence this is leading to unhealthy behavior—not just among Robinhood’s own customers, but industrywide.
You may have seen the news last fall that all of the big online brokers dropped their stock trading commissions to zero. While they didn’t acknowledge it, I believe this was driven by competitive pressure from Robinhood, which has grown rapidly and now has more than 10 million customers.
Again, on the surface, these trends may all appear to be consumer friendly. Aren’t lower prices better for everyone? Usually, that’s the case. But when it comes to stock trading, research has repeatedly shown that frequent trading leads to worse investment results. Even though brokerage commissions aren’t the only cost to trade, there’s evidence that the move to zero commissions has driven stock trading volumes through the roof. Recent data reveals that online brokers have seen trading volumes double over the past year.
What’s worse, the investment choices Robinhood users make are, in many cases, downright scary. Among the top 20 exchange-traded funds (ETFs) owned by Robinhood users, seven are leveraged, according to a recent review. What’s a leveraged ETF? It’s something so risky that last year Vanguard Group banned them from its trading platform—and yet this is a big part of what Robinhood users are buying.
While this is an isolated case, one 20-year-old Robinhood user tragically took his own life after misreading his balance and believing that he had incurred a $730,000 debt. How could this have happened? It turns out that he was trading a complex stock options strategy. In cases like this, an investor’s balance can appear negative until the entire trade has completed.
This isn’t unique to Robinhood, but rather symptomatic of a broader trend. Young people are being drawn in without sufficient education. In the note that he left for his family, this young man wrote, “How was a 20-year-old with no income able to get assigned almost a million dollars’ worth of leverage? I had no clue what I was doing.”
Who’s to blame for all this? I’ve singled out Robinhood, and I do believe it’s responsible for stoking some amount of speculative behavior. But it takes two to tango, and investors play their part—especially high-profile personalities. One in particular is a blogger named David Portnoy. The founder of a site called Barstool Sports, Portnoy explains that, “When COVID-19 caused sports to be postponed indefinitely a few months ago, I turned from sports gambling to day trading….”
On Twitter, Portnoy has 1.6 million followers. His posts and his videos are almost impossible to describe, so I’ll include a few quotes to illustrate:
This might be amusing—and, again, you might call me a stick in the mud—but Portnoy’s videos often have several hundred thousand views. Can I draw a straight line between these videos and anyone else’s risky stock market behavior? Of course not. But I see it as a data point to bear in mind.
What should you make of all this? Is this a warning sign about the stock market? As I’ve noted before, investing requires a healthy balance between optimism and pessimism. I’ve also cited reasons you should be optimistic. So please view this only as evidence to weigh on the other side of the scale. But in this kind of environment, I feel it’s even more important to stick to time-tested investment principles that, in my opinion, provide the best chance for long-term success:
If you follow that prescription, I doubt you’ll have as much fun as David Portnoy. But I do believe it’s the right path.
Adam M. Grossman’s previous articles include Too Slow, Sticking With It and Think Like a Winner. Adam is the founder of Mayport Wealth Management, a fixed-fee financial planning firm in Boston. He’s an advocate of evidence-based investing and is on a mission to lower the cost of investment advice for consumers. Follow Adam on Twitter @AdamMGrossman.