The dangers of free stock trading

The Thinker by Rodin

I noted recently the crazy things being done to inflate the stock market. It’s good in a way that the Fed and Congress are trying to keep Americans from feeling the oppressive weight of our economic collapse. We may have gotten a $1200 one-time payment and perhaps some extra unemployment compensation. But the biggest beneficiaries of government largess are clearly businesses, generally the large types.

But it’s not just any businesses. Small businesses may have gotten some short-term loans, but those that are publicly traded are getting huge shots of adrenaline thanks to government. The government has decided that markets are apparently too big to fail, so it’s going to insulate investors from its risks.

When markets begin to notice the actual underlying economy, the Fed usually comes to the rescue and creates a whole lot of money used to buy assets. This happened again just yesterday when the markets started to slip. With the supply of these stocks reduced, the price will artificially go up. This mostly explains why the stock market has nearly fully recovered from February and March’s downturns.

Along the way a lot of rich people got a whole lot richer. America’s billionaires added an estimated $434 billion to their fortunes during the pandemic. A lot of rich people were like me and saw the crisis coming when the first COVID-19 case was diagnosed. So they sold high and bought when prices were deeply discounted in March. The Fed was so alarmed by falling stock prices they righted the situation for them by buying stocks at inflated prices.

Most of us don’t directly own stocks. If we do, they are in retirement accounts and not easy to manipulate. I don’t own any stocks directly. They are all mutual funds and EFTs. Why? It’s because I seek safety in market trends. Buying in a pool limits risks, even if it may flatten rewards. Part of this strategy also includes not getting too overleveraged in any type of asset. Previously I was 50-50 on bonds and stocks. Now I am 60-40 bonds and stocks. So I made some profit from all of this, but it was a modest one.

Not so for our more moneyed class. Confident that the Fed will come to their rescue if things turn south, they are willing to buy and sell stocks directly. They look for drops like last week’s five percent plunge as a buying opportunity. They know the Fed will respond.

But there is arguably a new factor at work: millions of new day traders most of who arguably don’t know what the hell they are doing. Brokerages have generally stopped charging a commission to sell stocks. So anyone can now buy and sell stocks at no charge from their local smartphone. You don’t even have to buy full shares anymore. These companies will also allow you to buy fractional shares. So if you want to own just $5 in Amazon stock, you can do that. Since it’s currently trading around $2600 a share, fractional shares allow anyone to buy in.

These stock brokerages still make money. They make it from the cash balances in your accounts. This money gets loaned out, and I doubt it is FDIC insured. Some pay a tiny interest rate on these balances, like .01% APR. You could do a lot better keeping this cash in FDIC-insured banks instead, and there are some like Ally Bank (that I use) that pay a respectable interest rate.

Some Americans, particularly those doing reasonably well, saw their $1200 stimulus check as a reason to dabble in day trading. This “play money” has become investment money and may also be contributing to the high valuation of stocks at the moment. It’s arguably led to some crazy things. Lots of people are investing in bankrupt companies like JC Penney and Hertz, pushing up these stock prices when they may be dissolved and the stock could become worthless. “Sexy” stock tracking symbols also seem to be disproportionately overvalued. Some investors see a sexy stock symbol and with no other analysis figure they should own some of it.

So I’m not too surprised given that the Fed won’t let markets collapse and that people can now easily buy and sell stocks with no fees that markets are doing so well. At some point though you have to wonder if this house of cards will collapse.

Last week’s drop shows that investors occasionally wake up and realize, “Gosh, these stocks I own are risky and way overvalued! COVID-19 is not going away and we are in a deep recession that seems to be here for the long term. I should sell!” And they do until the Fed comes to the rescue again.

But at their core many of these assets are minimally wildly overpriced and are arguably junk. I sure wouldn’t be buying in financially stressed companies like Carnival, Delta Airlines or Hertz right now. Maybe I would buy some Delta stock if I were looking twenty years down the road. It is the world’s largest airline carrier so if any airline is likely to survive the crisis, it will. Some are betting the same with Hertz: it’s one of the original car rental brands, and it’s everywhere so even though it’s in bankruptcy court, it has to survive somehow and eventually be profitable, right? The government won’t let it fail, right? Well, maybe. But it remains a risky investment because demand has collapsed and the company is wildly overleveraged.

Or it could be that our economy is being wholly upended and that includes our markets too. It makes sense that some companies, like Amazon and Walmart, are doing so well. They are relatively well positioned to prosper in a new economy where delivery to the home can be done profitably. Investing in companies should be based in part on their agility, as well as a healthy cash balance sheet.

Yet so many companies are overleveraged with debt and offer a business model equivalent to the milkman of a hundred years ago. Investing in these companies is risky. I wouldn’t do it, but our smartphones let us make micro mistakes like this every day, at no obvious short-term cost.