Is The Stock Market Rigged?

Introduction: Welcome to the investor coaching show, a podcast to help you get an insider’s view of the financial world and escape common investment traps. We look at the financial news of the day and help you make sense of it so you can relax about money. And here’s your host, Paul Winkler.

Paul Winkler: Okay, so this is interesting. I did a little walk down memory lane this morning, unintentionally. I was actually reading an article and then I saw one of my clients go, “I want to find something on inflation, Paul. Can you tell me something about inflation?”

I go, “Oh yeah, yeah. You know, go to my website.” He knows the website: PaulWinkler.com. And I said, “You know, go look at the video-blogs, and podcasts–that section right there–and just put the word inflation in the search engine. You’ll find a ton of stuff where I’ve taught in depth on that.”

And he goes, “Well, you know, I’m a speed reader.”

And I said, “Well, you know, as a matter of fact, we happen to take the podcasts and it’s all transcribed. You can speed-read to your heart’s content.” And it’s actually pretty funny sometimes, the exchanges we get into it, when you see them in written form, you know. That’s pretty funny. So you can actually speed-read, but you can also listen to the podcast. You know, you’re driving down the road, you can’t hear the whole show on Saturday, you know. But in the week we go and put the podcast out there. Stuart puts the podcast out there. And then you can actually speed it up, right?

Evan Barnard: Yes.

PW: You can actually speed it up and listen to it. You know what’s funny? There was a lady that was talking the other day and it was a topic that was really complicated. And I was listening to her podcast and I actually had to go to 75 percent because she was… I was like, “Is it me?”

EB: And you’re listening with New York ears too. I mean, she must have really been flying.

PW: I know, yeah! She was setting the microphone on fire. Yeah. It was something fast. But you can do that, or you can either speed it up or you can slow it down.

The Death of the Stock Market?

PW: But anyway, High-Frequency Trading. So this guy was asking about that kind of stuff. Yes, it’s out there on the website. You can either read it. That website is so cool. I mean, I think it is really, really the bomb and it’s…I didn’t do it.

EB: How cool is it, Paul?

PW: Is so cool that I have to wear mittens when I–

EB: Just to touch the mouse.

PW: Yeah. Something like that. Okay, so, “High-Frequency Trading Brings Real Benefits, But Could Wind Up Hurting the Stock Market. Here’s Why” this was in Market Watch. Now around half of the buying and selling–so if you don’t know what high-frequency trading is, put your seat-belt on.

This is really what it is. This is neat stuff. This is kind of what’s going on right now. There were all kinds of programs on this. 60 Minutes did a show back in 2014, and they were interviewing. “This is going to be the death of the stock market.” It was horrible. I mean, it was. Yeah, if you actually watch this, this segment, I did a video on it, of all things. And it’s still on the website. If you go search on the website, you’ll find it. It was…I don’t even remember what the title of that one–It was, it was about, oh gosh–it’s something–Is the Stock Market Rigged. It just came to me. Is the Stock Market Rigged was the title of the video.

High-Frequency Trading Makes Trades Cheaper

But anyways, a while back I did it, and I really got into detail about what high-frequency trading is. So if you really want to know a lot about it, go back and watch that video because I’m not going to get into that much detail this time. But anyway, it says around half of the buying and selling of U.S. shares is by computer algorithms that measure time in nanoseconds or billionths of a second. Those high-frequency trading algorithms help make trading cheaper. Did you hear that? They help make trading cheaper, is what is said here in this article. Which is exactly the opposite of what that video that was on 60 Minutes back in 2014 said.

And, just so you get a little background for those of you who aren’t going to watch the video. I actually talk about high-frequency trading. And the point that I made in the video is: No, this isn’t going to make it more expensive; this is going to make it cheaper. And actually, there was an interesting study out of Marshall School of Business, where they showed how these increases in speed in trading were actually reducing trading costs.

And, you know, you have these places in Manhattan where they go and hollow-out buildings and they put computers in there because they can get, you know, a few hundred feet or a few thousand feet closer to where the trading’s taking place. And they can just shave off a nanosecond. If they can just do that, they can actually get a leg-up on their competition.

EB: And you think you’re going to be able to do that, sitting in your car in traffic, trading at the red light.

PW: Yeah. Good luck! Or in your living room.

EB: Yeah, at two in the morning.

Quit Stock-Picking and Market-Timing

PW: Yeah, exactly. It’s just ridiculous and good point, well-made. So you know, what happened is Gary Gensler, the chair of the Securities Exchange Commission got involved in this and he was talking about it. Dude did a little segment on CNBC about this whole thing. But you know, literally just made the point that this is ridiculous. You know, the reality of it is that no, this is not increasing trade.

But you had mutual fund companies going on there and saying, “Oh, this is getting us. This is killing us. This is terrible.”

And I’m going, “This is ridiculous.” And it turns out that it ended up being ridiculous. It actually did make the trading cheaper. It is in essence, what’s going on. Now, the point I made in the video was this: I said, “You know, even if this did increase the cost of trading, you know. You could very easily avoid all of the problems caused.” Quit trading! Quit stock-picking. Quit market-timing. And it’s not an issue for you, really.

But here’s what happens with this kind of stuff. And this is what drives me crazy about it. This does what to investors? It scares them from investing in the stock market because what they think–that the market is rigged.

EB: Yeah.

The Market Since 2014

PW: “It’s a problem. Oh my goodness. The big guy’s just going to take me to the cleaners. I need to not do this. I better just stay on the side.” And that is exactly what happened back in 2014. I actually pointed it out in the video that U.S. stock ownership was at an all time record low in 2014 because people thought that this was what was going to happen. It was going to be rigged and the whole system was against them.

Can any of you tell me what has happened to the stock market since 2014?

EB: Done pretty well.

PW: You think! Unbelievably well. And yet stock ownership was at a record low. There was an article in–this is a D.D. man speaking again in the walls–No. Think Advisor. Think Advisor, a publication written for financial advisors. Younger investors’ confidence, risk tolerance, rise with each trade. So what’s going on right now? 72% of Millennial and Gen-X investors said that they are confident in their portfolio decisions.

EB: Okay.

PW: Yeah. Yeah. As the pandemic begins to loosen its grip on the U.S., 72% of Millennial and Gen-Z investors said they are confident in their portfolio decisions. 70% of younger investors said the risk tolerance had increased in the last three months of the pandemic. That’s a real great time for your risk tolerance to go away, after the stock market goes up as much as it did literally from March of last year. But their risk tolerance didn’t increase till when? About, what? February of this year?

EB: Yeah.

PW: That’s when they all of a sudden start to invest.

EB: But it almost sounds to me like they’re conflating two things. I want to make sure I’m distinguishing that and understanding what it’s saying. So, I don’t equate, “I’m confident in my decision”–right– As, “I’m willing to take more risk.” Like, I mean, to me, they could be very confident and they’re risk averse. They just think they’re doing the right thing.

PW: Well, sort of. So let’s say that if I’m investing and I’m investing in the stock market, and I think of investing as investing in equities and that’s it. 58% of the investors under 34 are actually investing in equities. Now, if the stock market has been up significantly for many months and for many years, arguably, then all of a sudden they become confident in their investing in stocks. So they are sort of together in a way.

EB: Okay.

The Gamification of Investing

PW: 76% of Gen-Z and Millennial investors said that they trade at least once a week on their smartphone. Yeah! Yeah, you heard that right. 76% trade on their smart smartphone. They’re doing something really dumb on their smartphone. It is critical that they are–

Arlene: I thought they are just playing a game. They’re not investing. They’re playing a game.

PW: Well, no. That’s what they think they’re doing. You know, good point. You said that, Arlene and you just reminded me that that’s what Gary Gensler, the SEC Chair said.

Arlene: Yeah. I know. When they place the trade in their phone it has, like, sparkles.

PW: Yeah, graffiti and all that stuff. Yeah, exactly.

Arlene: And it makes you feel good. And there’s psychology behind that.

PW: Oh yeah, yeah. They call it the gamification of investing, is what they call that. Yeah. That’s exactly right. Good point. You know.

It’s critical for investors to stay committed to a disciplined trading–this is the advice in this article–“It’s critical for investors to stay committed to a disciplined trading approach during the dips and consider valuations and fundamentals at any one time before swift swooping in a new buy.” Now all of this is stock-picking and market-timing. Every last bit of it. To say that there is some kind of a discipline to stock-picking and market-timing is actually pretty laughable. There was an article on CNBC a while back and it was “Stock-Picking has a Terrible Track Record and It’s Getting Worse.” That was the title of the article. One of the headlines inside the article is “How bad is active management. It’s bad. And it’s getting worse every year.”

S&P Dow Jones indices does a study on active versus passive management. Last year, they found that after 10 years, 85% of large cap funds underperformed the S&P 500, and after 15 years, nearly 92% trailed the index. And that’s an asset category that you’ve heard us talk about here that in the last year has actually underperformed everything else. So they’re underperforming the under-performer. That’s really bad.

Second, the supply of capital chasing performance has dramatically expanded in the last few decades. In the 1950’s, there were fewer than a hundred mutual funds and only a few hedge funds. Today, there are more than $3 trillion in hedge funds and a lot more than that in mutual funds. It’s bad.

Now in this article, they’re saying that winning in this trading, this high-frequency trading, comes down to whoever’s fastest. Now the first high-frequency trader I spoke to in 2011, he says the fastest system could react in five microseconds. Met the same guy five years later. Five years later in 2019, it’s 42 nanoseconds. I don’t even know what a nanosecond is. I think it’s smaller than a microsecond though.

The Technology Behind High-Frequency Trading

EB: Probably.

PW: Yeah. Today’s speeds can’t be achieved with standard computer systems. You now need specialized silicon chips known as F-PGA’s. Field Programmable Gate Arrays. Not Gatorade. Gate Arrays.

EB: Gatorade. That’s good.

PW: This is insane.

EB: So what is, I mean, when you were talking about microseconds and nanoseconds. What was the law that we learned, you know, in 1996 or whatever.

PW: Oh yeah. Every 18 months technology–

EB: Well, like the computing speed, it was like, yeah. You know, there’s people screaming, right now–Brahm’s law or something. It doubled it every 18 months or something.

PW: It was. I knew technology was doubling every 18 months back in the late 90’s. Yeah. The trouble with speed-races is not what they cost. And that’s not cost as in “increasing costs.” They’re talking about the cost to play the game. You got to buy these stinking chips, and they’re not cheap. But then the same HFT Firm–High-Frequency Trading Firm–or small group of firms can keep winning them. And in the long run, it hurts competition. Yeah. That’s it.

Very few people can get in this game, and you’re probably not one of them out there. And this is basically what’s going on. And you’ve had some firms just basically disappear that are involved in this process. It’ll be hard for Gary Gensler–that’s the SEC Chair–and other regulators to make progress unless they underdress–they address the underlying–

Arlene: Underdressed?

PW: That’s what happens when Paul talks too fast.

EB: I wasn’t going to say anything and then Arlene jumped in.

PW: They, the address, the underlying–I was three words ahead–underlying speed-races. And that’s basically the gamification that’s going on in this arena. And yeah, you know, it’s interesting, what was happening. Because I was going through and looking at all of this old stuff that I had written about, and I was running into old videos that I’d done. And they’re still on the website. And you know, some of this stuff was unrelated. Some of it was related, like the GameStop thing. You know Phil Valentin–did the interview with him.

GameStop and the Greater-Fool Strategy

And it was interesting because I did the interview with him on January 29th. And on the 27th was when GameStop, that stock that everybody was talking about so much, hit $347 a share. $347 a share.

EB: Worth every penny, Paul.

PW: You think? I’m thinking it’s not, you know, cause it actually has been a pretty, pretty rough ride from that point on. Speaking of doing this, you know, the trading of those stocks and it’s–what do they call them? They call them meme stocks, right?

Arlene: Yes

PW: Because it’s just kind of this trendy thing to do. And that’s what people do is trendy investing.

Arlene: Oh, speaking of trendy investing, there was an article that’s saying that, you know what? Investors right now are having the greater foolish strategy in which a buyer pays a foolish price for something betting that someone else will pay even more.

PW: Right.

Arlene: And the greatest fool showed up at Sotheby’s Auction House $1.8 million sale of Kanye West’s Nike Air shoes.

PW: What’d they pay for them?

Arlene: 1.8.

PW: What? No, you gotta be kidding me. It’s not a typo?

Arlene: No, no. It’s not a typo. $1.8 million for Kanye West’s Nike Air Yeezy One. The most expensive pair of secondhand shoes. That means he has already worn it. Okay. Why would I buy it?

PW: No, no, no, no, no, no. That’s nasty. No

Arlene: And it was won by, not a person, but by an investment company because they’re planning to sell the shares.

PW: That’s worse than those–

Arlene: NFTs

PW: Yes. Non fungible–

EB: I can beat NFTs.

PW: No you can’t.

EB: I can beat them.

PW: No. Don’t tell me somebody is not doing anything dumber than that.

EB: An Italian artist sold an invisible sculpture for $25,000 this week. To an unnamed buyer, I think.

PW: I think they’re wasting more than the time limit I guess.

EB: That’s my new retirement plan. I’m going to sell invisible sculptures.

Arlene: So, so people are really–

PW: I am speechless. That doesn’t happen often.

Arlene: So that’s what you call the greater fool strategy.

PW: Yeah. Okay. So that’s insane. You know, I thought GameStop dropping a hundred dollars. A share was a bad idea, but that’s nothing. Okay. Yes, you win. Right. I concede

EB: To be serious though. Thinking about how you started this segment.

PW: Yes. Hi high-frequency trading.

Discipline or Get Rich-Quick

EB: I think, that for a disciplined investor, investing is not a rigged game. Capitalism is going to win. I think if you are engaging in all of this trading, if you’re engaging in the gamification, if you’re getting sucked into the advertising and hype, I absolutely think it’s a rigged game for those people that are trying to beat the game. It is rigged against people doing bad investing.

PW: You know, that is a great point. That’s out of the park.

Arlene: Most of our clients, they just really want to have a good retirement lifestyle, not a get rich quick scheme.

PW: Yes, and the point that we always make, yeah. And that’s what’s happening is people get desperate. You know, sometimes it’s younger people that’s just naive. They don’t know what they don’t know, and they’re just jumping into this thing for the first time. And as a matter of fact, in the last hour, I’m going to get into one that’s really, really interesting in that particular area. But I think that’s what happens is it’s just, “I’ve never done this before. I don’t know what, I don’t know.” I don’t realize that I’m in over my head and you lose. But then you get the older investor that says, “I am a way, way behind on my retirement plan and I’ve got to catch up.” So then they get sucked into the game as well.

But the reality of it is, you own companies. It is dysfunctional, if I were to go and say, “Hey, I got this financial planning firm.” And there’s Joe’s Hardware Store on the other side of town, and every couple of years we traded businesses with each other. See? People would look at us and go, “There’s something wrong with you, seriously wrong with you.” And yet this is what people are doing by trading stocks all around, back and forth. They’re just trading with each other.

And the reality of it is, that is not the way wealth is created. It never has been. You’re just–you got a lot of friction costs, not alone, not even to mention the psychological aspects and the mistakes that people make psychologically when they invest in that particular manner. It is a game that ends up being lost in the long run and investors are the big loser.

EB: All right. Let’s change gears now.

PW: Okay. So one of the things that you should do as an investor–What are you doing? Okay. Forget it. I know what you’re doing.

EB: I’m working on selling my air trumpet solo, it’s like a musical sculpture.

PW: All right. So when a portfolio is to be managed, there are things that go beyond just buying mutual funds and trying to pick the right mutual funds that you hope are going to make you financially successful and have a nice secure retirement.

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*Advisory services offered through Paul Winkler, Inc. (‘PWI’), an investment advisor registered with the State of Tennessee. PWI does not provide tax or legal advice: please consult your tax or legal advisor regarding your particular situation. This information is provided for informational purposes only and should not be construed to be a solicitation for the purchase of sale of any securities. Information we provide on our website, and in our publications and social media, does not constitute a solicitation or offer to sell securities or investment advisory services, or a solicitation to buy or an offer to sell a security to any person in any jurisdiction where such offer, solicitation, purchase, or sale would be unlawful under the securities laws of such jurisdiction.