Stock markets provide amazing opportunities for regular people to grow their wealth in a life-changing way. Disciplined, long-term investors with regular investments have been historically well-rewarded through the power of compound interest. However, there are dangerous narratives building around the stock markets and investing in general, that threaten the success of investors going forward. In this article I discuss 3 warnings for investors in current market conditions.
#1 – Stocks don’t always go up
If you take a very long time horizon, the stock market as represented by the S&P500 index has done very well.
However, that doesn’t mean the index goes up linearly.
There have been periods where the stock prices have gone nowhere for a decade or even more.
As we approach historically high valuations on the U.S markets, that’s something to consider.
And that’s the S&P500 index alone, which selects U.S stocks based on their market capitalisation size and actively removes and adds companies to the index.
Expecting similar returns from any individual stock is a grave mistake to make. Individual stock investing is a great way to create your investment portfolio according to your personal goals, but it requires a lot more analysis work and active management. Just because a company is trading on the stock market, doesn’t mean that it will give you historical average stock market returns, or any positive returns at all.
Dividend investors can take heart from the fact that over the last 40 years, around 70% of S&P 500 returns have come from dividends. As dividends rely on strong business performance, not stock market sentiment, they are a lot more reliable stream of returns than stock prices.
#2 Companies in “hot” sectors won’t automatically be great investments
This narrative-based investing approach is arguably the most popular strategy amongst new investors right now.
Just consider one of those “hot” sectors from the last decade – 3D printing.
The largest 3D printing company 3D Systems Corporation(DDD) was bid up to almost $100 per share in 2013 as investors thought it would be a disruptive technology in the near future. As that failed to materialise, the stock price declined by more than 90% in the following 2 years. Even now in 2021, the company’s share price is well-below its 2013 highs.
There are EV companies out there that haven’t sold a single car, but whose stock prices are soaring because of the sector they operate in. Will every single one of those EV companies be gushing cash flow in the future? I doubt that.
For example, where Google has done extremely well, competing search engines such as Open Text, Direct Hit, WebCrawler, AskJeeves and many others didn’t enjoy similar “success by association” for being in the same business.
#3 IPOs and SPAC IPOs – it’s not the retail investor that makes money on it
IPOs
IPO returns might look impressive at first sight. You see many of them shooting up on the first day of trading for whopping returns.
Does the retail investor participate in that rally?
Unlikely.
The difference between offering price and opening price is something we need to understand when it comes to IPOs.
The offering price is the price at which a company sells its shares to investors that are sourced by the underwriter (investment bank) – who structures the IPO and finds potential investors. Those shares are offered to the bank’s institutional clients and sometimes accredited investors. Large majority of retail investors don’t have an opportunity to buy shares at this point.
Once the IPO is opened for all investors and starts trading on the public stock market, the shares are trading at the opening price. The opening price is determined by the buy and sell orders at the time of open. The large majority of gains are made by the institutional investors before the retail investor has the chance to buy any shares.
| Company | Offering price | Opening price | Difference |
| AirBnB | $68 | $146 | 115% |
| Snowflake | $120 | $245 | 104% |
| DoorDash | $102 | $182 | 78% |
SPAC IPOs
Investors who put their money in SPACs at an early stage have no idea what they will be eventually investing in, as the SPAC doesn’t disclose its target for the merger. That’s why SPACs are also called “blank-check” companies.
Let me share with you the research from J.P Morgan on who benefits from those investments.
On the table below are the median returns over the last years for the following investments
| Investor who buys SPAC shares before merger | +45% |
| Investor who buys SPAC shares after the merger | +10% |
| SPAC sponsor who brings it to market | +682% |
