Many young investors are wading into dangerous territory.
Investors who forget that what goes up must come down do so at their peril. For many people aged less than 25, it is a lesson they have never learned and are unlikely to learn until it is too late, thanks in part to excess government regulation.
To understand that point, start by considering how easy it is to trade on financial markets using one of the many smartphone enabled applications.
Empowering as the apps are, they generally do not come with any form of advice as to whether an investment is good or bad.
High-quality advice is available, for a fee, and only after jumping through hoops to open an account with a reputable adviser. This is because government regulators believe that intrusive personal questions about assets, liabilities and objectives are necessary to protect the investor from unscrupulous and/or incompetent financial advisers.
Perhaps the ‘know your client, know your product’ rules advisers have to follow are well-meaning and understandable after multiple past examples of investors being ripped off by dodgy operators and, in some cases, big banks.
However, the regulations themselves have become a new form of risk because of the way they lead small investors into the world of advice-free internet share trading.
Three recent events highlight what’s wrong with investing today and why it is time to consider what comes next in the boom-bust-boom sequence on the stock market.
The first factor is the lightning-fast recovery from last year’s COVID-19 economic crash.
In Australia, the 33 per cent stock market fall of early last year has been fully repaired. In the US, the recovery has been even faster, with a 34 per cent meltdown shrugged off in just 126 trading days.
Driving stock markets higher is a combination of ultra-low interest rates on cash and bonds and the remarkable rise of fearless young share traders, driven by a desire to get rich quick and a belief that share tips on the internet are as good as paid professional advice.
Tik Tok, and similar social media platforms, are the second factor in today’s red-hot market, with millennial investors soaking up what they believe to be sound financial advice because it is targeted at them and does not come with a government wealth warning (and it’s not something their parents use or understand).
In the US, a Wall Street Journal report found that 41 per cent of Generation Z investors (those born after 1997) said they had used Tik Tok for investment information in the past month.
Given the way Australia follows the US in most technology trends, it is reasonable to imagine that young investors here are also turning to totally unregulated social media investment websites because they believe the officially approved advice process is expensive and only applies to old people.
The third factor adding to the near certainty that we are heading for a substantial correction is the return of high-risk debt as an acceptable asset class.
Yields on junk bonds in the US – a class of debt issued by the worst-rated companies – have fallen to their lowest in seven years as the hunt for a return by income-starved investors moves into hyperdrive.
The current spread between US government bonds and debt issued by companies in danger of defaulting is 6.5 percentage points, close to the lowest on record.
One of the few occasions it was less was in early 2008, just before the GFC.
After the next market correction there will be a government inquiry into the cause, which will be a complete waste of time because the causes can already be seen. They are:
• government regulation pricing young investors out of the market for sensible advice into the unregulated world of free social media advisory services;
• easy credit and ultra-low interest rates being maintained beyond a sensible point in the name of economic stimulus; and
• an inevitable rush for the exits at the first whiff of higher interest rates.
Most of those factors are well understood and are part of a normal investment cycle.
The difference this time is a class of young investors who have no idea what’s heading their way because their learning has been confined to video bites and hot tips from ‘advisers’ on social media beyond the reach of government regulators.