- Equity markets are driven by the twin emotions of fear and greed, and rampant speculation is a key feature of greed running amok.
- While pockets of speculation have appeared in the stock market, nobody does speculation quite like cryptocurrencies.
- This works out extraordinarily well for the speculators on the way up, but when greed turns to fear significant damage can be done in a hurry.
- Our portfolios don’t engage in speculation but instead focus on securities with real businesses and cash flows behind them, providing a backstop of fundamental value.
- Adding a dose of speculation to one’s portfolio has the potential to accelerate a financial plan, but more often than not leads to setbacks that can take years to recover from.
When discussing the emotions associated with investing at market extremes we often refer to fear and greed. The majority of the time markets climb a “wall of worry” and trend higher despite the never-ending stream of bad news. When we do get a streak of good news and the markets buy into it and put up higher than average returns, the potential for greed kicks in. As Warren Buffett says: "You can’t stand to see your neighbor get rich knowing you’re smarter." More often than not, that fictional neighbour is engaged in speculation rather than long-term investing, and in the short term it can produce results.
Take cryptocurrencies – nobody does speculation better! While the top two or three cryptocurrencies, led by Bitcoin, have a large institutional following, there are dozens if not hundreds of also-rans that have found an audience of speculators. Now in case the risks inherent in a product with no assets backing it and no cashflows wasn’t risky enough, you may be surprised to learn that many people use extreme amounts of leverage to “invest” in crypto. We are talking 20x, 50x, even 100x leverage on something that historically is much more volatile than stock indices.
The reason we bring this up is to show the other side of speculation. On October 10, equity markets fell sharply on a new round of anti-China tariff rhetoric from the U.S. administration. A tough day for investors, but nothing out of the ordinary. In crypto it was another story – many smaller coins saw short-term declines of 40%+and 1.6 million traders had their accounts liquidated, or sold out completely because they did not have enough assets to cover their borrowing. While an extreme example to be sure, this is what the other side of speculation looks like and it isn’t pretty!
While it is to a much lesser degree, there are pockets of speculation in the stock market as well. The runup in gold has reignited interest in mining companies that have little more to their name than a land claim and a few holes in the ground. We have seen supposed nuclear reactor plays with zero dollars of revenue that have grown to market capitalizations the size of large Canadian telecommunications companies and quantum computing companies that don’t screen much better. The list goes on.
The important thing to know is that this is the antithesis of how we invest for clients. We don’t engage in speculation, full stop. The businesses we invest in have real assets and cash flows, providing a fundamental backstop when markets swoon. The same cannot be said about the examples above, despite in some cases breathtaking performance this year. Long-term investors often see the returns in speculative securities and are tempted to jump in. After all, a successful endeavor in these stocks has the potential to accelerate the growth trajectories laid out in a financial plan. More often than not, however, taking a detour into speculation leads to setbacks that can take years to recover from.
The Harbour Group
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