Things individual investors should not do in 2021
Tl;dr
Do not buy individual stocks unless you are a professional investor
Do not buy “growth” funds
Do not keep on waiting until it’s time to “buy low”
Do not short the market
Do not buy cryptocurrency
Story begins…
Investing in current economic environment is tricky. The stock market has been soaring in the past decade. Overnight millionaires were made by series of upward market movements. Is the market now too high to buy? Or is the bull market going to continue for a few more years before it runs out of steam?
Let’s go over some major events in the last ten years. All dollar values expressed are in US dollars.
S&P 500 went from $1,257.62 in 2011 Jan to current $3,906.71. A 210.64% increase in 10 years corresponding to a compound ROR of 7.73%.
Dow Jones went from $11,577.43 in 2011 Jan to current $31,494.32. A 172.03% increase in 10 years corresponding to a compound ROR of 5.57%.
In the US, inflation rate briefly shot up from 1.64% in 2010 to 3.14% in 2011, and was maintained at a relatively constant level between 1.5% to 2%. In 2021 the inflation seems to be on the rise, ending at current 2.24%, a likely impact due to Covid. A similar picture exists for Canada with slightly lower numbers on average.
In the bond market, the medium term US treasury 10Y yield went from 3.36 in 2011 Jan to current 1.34, and long term US treasure 30Y from 4.39 in 2011 Jan to current 2.14 (note that it’s advisable for individual investors to not buy the extremely long term bonds as their values are heavily dictated by interest rates). The decline in rate perhaps reflects the under supply of safer investments, and hence the market’s fear about the level of risks in this economical environment.
As an example of stock market movements, we turn our attention to Amazon and Tesla. The former was the hottest stock three years ago, and the latter very recently (although it seems to be dropping out of the public view now, eclipsed by the GameStop debacle and bitcoin price surge).
From 2016 to 2018 Amazon’s stock value skyrocketed from around $300 to $2,000, and now is at $3,249.90. With a current P/E ratio of 77.7, it’s way past the conservative price range but compared to many growth stocks in the boom period this P/E ratio is not obscenely high. However, we need to keep in mind that Amazon is now a company of colossal size. With a revenue of 280 billion dollars, it’s hard to imagine that Amazon can grow at a rate that justifies the current P/E ratio.
Tesla is even more of a fairy tale story. In the beginning of 2020 the Tesla price started at $88.6 but at year end it multiplied ten fold yielding a price level of $880.02. At the time of writing Tesla’s stock price is still at a very high $781.30, giving a P/E ratio of 1,226.3(!!). For a company whose main business in car manufacturing is far from rosy, this price seems highly speculative. When the price collapses, it will hurt millions of shareholders to enrich just a few (Tesla’s current total shares outstanding is 960 millions).
We can thus summarise the present economic situation: the stock price is at all time high with many “growth” stocks fabulously or rather delusionally priced, yet there is no safe haven to preserve capital value since bond yield and interest rate are at all time low. In a way the outlook is even worse than the internet bubble in late 1990s. In late 1990s at least fixed income products have relatively attractive rates (US treasury 10Y at 4.69 and 30Y at 5.15). It’s also important to note that inflation rate is likely to be on the rise given Covid will inevitably depress manufacturing.
I have been considering how difficult it is to invest for a while. Although I still don’t feel confident about making a decision, I want to reach that decision by a process of elimination. Because after all, in investing as in many other things in life, knowing what not to do is more important than knowing what to do.
Things I recommend amateur investors not do for the remaining time of 2021 are:
Do not buy individual stocks unless you are a professional investor
Many stocks offered right now are highly speculative, and their existence is also highly speculative in nature. In boom time, it’s almost unavoidable that many poor quality new issues come into existence through the process of IPO. In the optimistic market they can be branded as growth stocks and sold to unaware public. In fair weather these stocks can even outperform the market for a few years, but this performance has nothing to do with their underlying value, but is related to the general public’s over optimism. When market crashes, most of these stocks can lose from 95% to 100% of their value.
As an amateur investor, just remember that there is a lot of talented, highly motivated people who have been working tirelessly in the investing world for years, and only a very few percentage of them managed to “beat” the market consistently.
For average amateur investors, there are three fold difficulties in picking stocks. One is lack of deep understanding of stock stats, two is lack of mental discipline to stick to a predefined strategy. Three is that even when the investor clearly understands how to invest in a stock, has a plausible strategy and the mental strength to see it through, he still needs to have the financial and accounting knowledge plus a hefty chunk of time to scrutinise the annual reports of the companies he wishes to pick. It’s hardly surprising that many companies will cook their books in a bull market to take advantage of the public enthusiasm to buy stocks, producing many “technically correct” but highly deceptive numbers by one accounting practice or another (watch out for special charges, non-recurring expenses, expansion through merger and acquisition, unusual fluctuating earnings and more in annual reports).
Bottom line is, if you are amateur and you don’t have tons of time to study the market, analyse the companies’ annual reports, have easy access to investment counsellors you trust, don’t start picking individual stocks in 2021. Doing so is like trying to fly a Boeing 747 in stormy weather when you just got your first flight lesson.
Do not buy “growth” funds
Growth funds consists of stocks which are considered by the market as having superior growth potential. Superior growth potential can either mean that the stock currently has an exceptional earnings growth, or simply that the market thinks it will earn a lot more in the future. In other words, a stock may not even need to make money right now to be a growth stock, it merely needs to rank high in public opinions.
In recent years, the growth stocks probably fall into the categories of technology and healthcare, which were incidentally also the growth categories back in the late 1990s. I am mentioning this fact as only an anecdote. This similarity is not an ominous sign of market troubles. It just shows the growth drive factors have not shifted for more than twenty years.
Because growth funds will focus on the select few “hot” stocks in a narrow range of industries, an investor buying into growth funds does not diversify his portfolio properly unless he also buys other industries and other non growth companies. Another problem is that the growth stocks will without a doubt have a very high P/E ratio if they are well regarded, and if they have a reasonable P/E ratio (this value is for you to judge, the current S&P P/E is 39.78 which I consider to be too high; 10 to 20 is more reasonable) it’s almost guaranteed that they are secondary stocks.
On the one hand when an investor buys a stock with very P/E ratio, the premium value of its superior growth is already reflected in the price. If the stock is going to make money in the future, there are only two ways: one is the market speculation pushes the price even higher; two is the company grows at a rate even faster than anticipated. Either way you are gambling on the chance that you can predict the future.
On the other hand when an investor buys a secondary stock with supposedly promising outlook, he is again betting on the chance that an obscure company will fare well in the next few years and produce more than satisfactory outcome. If the company is not obscure and its growth prospect is well known, it will not have a reasonable P/E ratio in a bull market. Just because the market condition is good right now, it doesn’t mean it will still be good in the next year. In fact, smaller companies are much more likely to go bankrupt with the slightest market turbulence than well established companies.
Last word of warning, in 2000 market crash most growth stocks lost 99% of their value.
Do not keep on waiting until it’s time to “buy low”
In a bull market, some investors will see the trouble on the horizon earlier than others. If we take lessons from the history, we can see that with major economic cycle from last market crash lasts about 30 to 40 years (in the US market crashed at 1929, 1969, 1999. Between these market crashes, the period is marked with events with smaller time scale like depressions, minor recessions, ten year boom and temporary price adjustment periods that masquerade as short-lived recession and boom).
We are in the stretch of the longest economic expansion in history, does it mean that the house of cards will come crashing down any time now? Maybe, perhaps, who knows. Something we are doing seems to stretch out the boom much longer than before, maybe it’s the government’s relentless effort to prevent recession, but the underlying reason doesn’t matter in this consideration for average investors. Even if the cause is well understood, an amateur investor should not project the future by reasoning out the cause and effect. Doing so is again predicting the future which will be futile.
Some investors may want to opt out of stock market all together and wait for the prices become low enough to buy. To be honest, I have been harbouring this idea for a long time before finally abandoning it. The reason for that is we will never know how much longer this boom period will last. If an investor switches his portfolio to all bonds and the market continues an upward movement for the next five years, his portfolio will lose value due to inflation and he would have missed the stock gain of five years which can be equal or more than the total capital he invests initially.
Perhaps the answer is the timeless wisdom of putting your eggs in as many baskets as you can find and spread the risk. It means keeping a balanced portfolio of bonds and stocks, with the a larger percentage of bonds to protect the principal of your investment but some proportion of stocks to capitalise in the stock market gain.
Do not short the market
With the same arguments just listed for the previous “do not”, amateur investors should not short the market. If the market price keeps on rising for the next few years, you need unlimited deep picket and nerves of steel to survive until the fateful crash, which may not even materialise in your life time. Just because the geniuses in the movie “The Big Short” shorted the market and became fabulously rich, it doesn’t mean you can pull off the same trick.
Shorting the market can easily ruin any investor, individual or institutional. If you are going to speculate against all conventional wisdom, limit your potential loss to what you can accept.
Do not buy cryptocurrency
Bitcoin’s price history can be described only with the wildest adjectives. From a humble beginning of worth almost next to nothing to now $57,051.70/BTC, Bitcoin has blossomed like the Dutch Tulip mania. What does paying $57,051.70 for a bitcoin give you? You get an electronic encryption stored somewhere in someone else’ computer.
If you are going to bet against anything, short Bitcoin; but that goes against what is just prescribed in the previous “do not”, and it can easily ruin you too.
The idea of cryptocurrency can be onto something. It can perhaps eventually establish one currency for the whole world, democratise money printing and make payments easier and more secure. However the price behaviour of Bitcoin is not rational at all.
Currently Bitcoin is backed by no one, no institution, and it has no inherent value. In fact we are wasting useful energy to just keep the decentralised system from shutting down.
In the future it’s possible that by a strange twist of fate, Bitcoin becomes the gold of new age because the exponential difficulty to create more bitcoins lends value of rarity to it, and it’s also possible that the whole system gets thrown out of the window when we finally confront the urgent and practical question of energy consumption and environmental damages. It’s up to every individual to take his stance in this future prediction, but it’s also every individual investor’s obligation to themselves to not act on mere opinions by betting for or against cryptocurrency.
Final Words
Investing in year 2021 will not be an easy decision. At the time of writing, I am still trying to do as much research as I can to gain a better understanding. Maybe the correct action is to keep a balanced portfolio between bonds and stocks, perhaps it’s to take a look at real estate in places where prices are still attractive (after remote work seems to become popularised now and can stay in the future). I can offer no good advise on what to do but plenty opinions on what not to do.
By the end of the day, I think it’s better to be safe than sorry. Hopefully you find this article helpful, if anything I hope it at least curbs your enthusiasm to jump in the market head-first.
“Blessed are the meek, for they will inherit the earth”.
