In this weekend’s reading, one theme featured prominently that is close to heart: the idea that younger Americans are “shying away from stocks” as a result of a full decade without appreciation in equity market valuations. The Reformed Broker offered the following “funny because it’s true” summation of the Generation Y-er mentality towards equities:
“Stocks go up, Mom and Dad buy a lot of stuff.”
“Stocks get killed, college tuition has now disappeared, our house is on the market and there won’t be any job for me anyway.”
While I think there is much truth to the concern as to the lack of risk-tolerance from the youngest of Americans towards equities as an investment class, there is more to the story than meets the eye. As one such Generation Y-er, whose family grew up with dinner table conversations about specific equities and the future of particular companies and stocks, I was not necessarily unique, but was more attuned to the stock market than many my age. That continues to this day. However, sometime between high school and early college, my attention to equities stopped being remotely unique. In law school, where each and every student now plugs into the Internet during every class, I often saw my fellow students’ browsers navigate over to eTrade, Ameritrade, or whatever other discount broker was offering the best rates.
Much like the poker trend that raged through America, so too has the notion that in the shorter time-frames, equities offered great risk/reward opportunities for a quick buck. People my age don’t talk about which company to own for ten, twenty or even thirty years, but they do talk about stuff like whether Citigroup under $1 is worth a trade (I know several who took this chance), if Apple with the much-hyped iPad launch is a “quick short” or which solar company is the best for a quick run-up following the Gulf Oil Spill.
Notice the common trend: all are trades of the shortest-term variety. It’s not that my peers want nothing to do with equities, quite to the contrary in many cases, however, very few think of equities as a long-term investment vehicle through which people invest in “real” companies (I say real cynically here, because many think every trade is the same and the names are merely the vehicle through which to conduct that particular trade).
Turning to a visual, the average holding period of equities clearly demonstrates the rise of short-termism (source: Seeking Alpha):
A generation ago, people held stocks for years, now they barely hold them minutes. Why is that? Well I think a few themes are at play. With specific regard to equities, cheaper transaction costs are certainly a direct cause behind the reduced holding times. In my recent interview with Justin Fox, we spent some time discussing the Flash Crash and one possible cause that several academic studies site is the increased instability in the market that stems from short-termism. Justin had the following to say:
In general, standard finance theory holds that cheaper transactions would lead to a more efficient market. I think we’re reaching this point where that’s not entirely true. Yeah, high frequency trading is helping to enable increasingly lower commissions in terms of trading stocks. But at the same time, it might be that it brings with it the potential for weird, chaotic fluctuations now and then.
It may be that it was just a case of poor structure and poor interaction between the electronic markets and the NYSE. But I just wonder … and this is something I do talk about in the book. This really interesting simulation experiment that was done at Santa Fe Institute that I think started in late ’80s, where they created these artificial traders and had them trade with each other in order to see what ended up. What they found was that if traders sort of didn’t change—took a while to process new information and waited a reasonable period before changing their opinions about the markets, you ended up with markets that were relatively calm and move towards equilibrium. But the more you sped up that decision-making process and information and everything else, you actually got a market that was more prone to bubbles and crashes.
I think we’re seeing a market that, by the finance academics’ standards of efficiency, is more efficient than it ever has been before. But by the standard of getting prices right in a calm and reasonable way, and doing a good job of allocating capital at all times, it might have actually gotten worse over the past 25 years.
There are two crucial points here. First is that cheaper transaction costs ultimately lead to more transactions, which in turn leads to more volatility, which again leads to more transactions, thus compounding the rate at which holding times decline. The second is encapsulated in the first point but deserves attention in its own right–cheaper and more frequent transactions do not necessarily lead to more efficient valuations, therefore making it far more difficult to gauge a company’s intrinsic value at any particular instance in time.
Beyond just the cheaper transaction element, there is a broader theme at play. Everything today moves at the speed of light, whereas in the past things seemingly eased along at a tortoise’s pace. With the Internet available not just at the desk, but on the go, Twitter, Facebook, Google Trends, and whatever else, everything new is old in a matter of seconds. Specifically with regard to equities, many saw their parents make and lose money at such a furious pace in the late 90s and early 2000s that investing lost and trading gained in meaning and prominence. While many Generation Y-ers still do in fact seek employment in the financial sector, no one grows up with the intent of becoming an investor.
Never do I hear that about the “hedge fund investor” but often do I encounter the “hedge fund trader.” Traders are fast, sexy, cool like Gordon Gekko and investors are old, slow and boring like Warren Buffett. Granted Warren Buffett has become fabulously wealth over time with sound investment principles; however, many would prefer the prospect of a rapid ascent rather than a slow and steady climb. People used to climb mountains for thrills, now they jump out of planes. In the collective mindset of my generation, poker and equities are not all that different–both provide the prospect of fortune and fame, boom and bust, with heart-wrenching twists and turns that test the psychological meddle of even the strongest man.