The Horror of Change

The horror of change... Retail investors haven't changed their destructive behavior... Institutional investors are human, too... Extreme duress hasn't arrived yet... The Fed won't change until the pain becomes unbearable...

As humans, we don't like changing our behavior...

It doesn't matter if the behavior is obviously stupid or destructive, either.

We would rather find some way to justify it than change it.

I (Dan Ferris) am convinced that's why many people seek out therapists...

Therapists might naively think clients want help changing a stupid or destructive behavior. The clients might say they want help changing – and they might even think that they do.

But what they often really want is to pay someone to tell them they don't need to change.

Many bestselling self-help authors realize this idea, too. That's why they make more money than most therapists. Just look at a few of the genre's most popular titles...

• You Are a Badass: How to Stop Doubting Your Greatness and Start Living an Awesome Life

• Quiet: The Power of Introverts in a World That Can't Stop Talking

• The Gifts of Imperfection

These titles all seem to be designed to let you know you're fine and don't need to change.

The world is messed up, not you. You're an imperfectly introverted little badass.

Humans will do anything to justify not changing their bad behavior. They'll twist their minds into shapes so impossible that M.C. Escher would kick himself for not thinking of them first.

They'll do whatever it takes to avoid the horror of change.

That brings us to the following chart from the Financial Times...

The financial-news publication featured this chart in an article at the end of last week. The article was titled, "Meme-stock 2.0: Wall Street's retail trading boom is back."

Oh boy.

More specifically, the chart shows the average daily stock market inflows from retail investors over the past decade. It recently hit a record $1.5 billion per day. Take a look...

The Financial Times is actually wrong about this chart...

It doesn't show that retail investors are back. If you look closer, it shows they never left.

Even the lowest daily inflows since 2020 were much higher than the highest inflows as far back as 2014.

Bear market or not, retail investors put the pedal to the metal in 2020. And they still haven't let up.

Even worse, they haven't changed their destructive behavior...

They're still shopping in areas where they've gotten burned already.

For example, they're still dabbling in special purpose acquisition companies ("SPACs").

Regular Digest readers know these "blank check" companies sell shares to the public to raise money, often without an actual business in mind. They promise to acquire one within two years.

If the SPAC sponsors acquire a business, they walk away with a 20% ownership stake for doing practically nothing. If they don't acquire one, they must return the money and won't get rich.

As a result, many SPAC sponsors just settle for any company. That's what they're rewarded for doing.

Now, not all SPACs acquire garbage companies – but many of them do.

And yesterday, a bunch of SPACs went absolutely nuts as the retail crowd piled in. From Bloomberg...

Ocean Biomedical Inc. at one point surged as much as 453% Thursday, triggering at least 11 trading halts before cutting gains to 125%, while special-purpose acquisition companies Genesis Growth Tech Acquisition Corp. spiked as much as 163% and Lionheart III Corp. soared as high as 113%. Genesis Growth's rally was trimmed to 64% as gains for Lionheart III mostly evaporated...

The risks that come with chasing rallies were also on display Thursday. Intuitive Machines Inc., which had soared 1,200% in a raucous stretch to briefly become the best performing ex-SPAC, tumbled 75% on Thursday. The stock has wiped out 85% from an intraday high hit on Wednesday.

It's like these retail investors are wearing special glasses that only let them see garbage stocks. If they type in "Berkshire Hathaway" while wearing them, the screen goes blank.

The retail crowd obviously isn't changing. It's sticking with the new status quo.

These investors learned in 2008, 2019, and again in March 2020 that the Federal Reserve has their backs. They concluded from those episodes that no dip is too scary to buy.

Just look back at the above chart...

In March 2020, stock market inflows from retail investors shifted into high gear...

The 33-day COVID-19 bear market in 2020 ended as quickly as it began.

Starting on March 23 of that year, the newly lobotomized and subsidized masses put their government stimulus checks and unemployment toppers into a giant punch bowl at the biggest speculative party ever held.

Since then, like every good human, they do whatever they can to not change. They only stray from the new status quo under the most extreme duress. (We'll get to that in a bit.)

Retail investors never seemed happier or more confident than on November 17, 2021. That day, U.S. stocks hit their all-time peak value of $54.4 trillion, according to Bloomberg data.

But the thing is...

That was the single worst moment in recorded history to believe the future of U.S. equity returns looked bright.

In fact, as the tech-heavy Nasdaq Composite Index peaked two days later, that's what I said right here in the Digest...

My sense of resolution about the unattractiveness of most stocks today is stronger and clearer than ever...

I'm more bearish about stocks today, November 19, 2021, than I've ever been in my life about anything.

You could say that my bearishness just hit a new all-time high.

We all know what happened from there... 

Stocks plunged throughout all of last year. They slid into an official bear market.

And yet, that still didn't break retail investors' sense that any and all dips are buyable.

It's not just retail investors. Institutional investors are human, too...

Of course, they don't blather on about sending AMC Entertainment (AMC) "to the moon."

But in some ways, they're worse than retail investors...

That's because they have more money to play with than retail investors.

It allows the humans inside those institutional investors to push the status quo harder for longer. They'll push until the market's duress punishes their clients badly enough to put them out of a job.

Take Cathie Wood, for example...

Wood still has her job as founder, CEO, and chief investment officer of ARK Investment Management. She's still spending clients' money while refusing to change her behavior...

Wood's flagship ARK Innovation Fund (ARKK) is down about 75% from its February 12, 2021 all-time-high closing price. In the February 13, 2023 Digest, I called it "my favorite publicly traded garbage can" due to it containing a bunch of money-losing, tech-trash stocks.

But Wood isn't deterred by the fund's miserable performance or knowing full well that the average ARK investor has lost money since its inception. On February 2, she told Bloomberg TV...

[ARKK is] the new Nasdaq.

Yes, she was serious.

Wood's rationale was that ARKK had outperformed the Nasdaq handily for one month.

From the end of 2022 through February 2 of this year, ARKK was up about 40%. Meanwhile, the Nasdaq had gained around 17% over that span.

Well, the market took Wood's comments as a contrarian signal...

ARKK is down roughly 14% since then. That's around double the Nasdaq's drop over that period.

A few weeks isn't enough time to establish ARKK's alleged superiority over the Nasdaq – or vice versa. Still, it's obviously crazy behavior...

A few dozen, mostly garbage names make up ARKK. Many of the most cash-gushing tech companies of all time rule the Nasdaq.

Which one do you think will do better over the next 10 years?

But ARKK's obvious inferiority hasn't caused enough pain yet...

So the status quo will continue. Retail investors will refuse to change their behavior...

ARKK will likely keep outperforming the Nasdaq during rallies. And it will likely keep underperforming the index on declines.

Eventually, this process will wipe out retail investors. And they'll have no choice but to leave the market.

Then, moribund companies like Bed Bath & Beyond (BBBY), GameStop (GME), AMC Entertainment, and Carvana (CVNA) will lose the only folks dumb enough to buy them. And finally, they'll slip into oblivion where they belong.

(If you think I'm obsessed with this stuff, that's a fair critique. But nobody else talks about it. And it's a huge mistake for folks to ignore it.)

We can't talk about changing only under duress without mentioning the Fed...

As a massive bureaucracy, the central bank's track record in terms of this behavior is legendary.

St. Louis Federal Reserve President James Bullard wrote a piece last June about the lessons the Fed learned about monetary policy during inflation starting in the 1970s. In it, he said...

In 1974, the [Federal Open Market Committee] focused on nonmonetary factors affecting inflation – such as government budget deficits, oil price shocks, and "excessive" price and wage increases by firms and labor unions – as opposed to monetary policy. It kept the policy rate relatively low, even in the face of rising inflation...

What followed was high and variable inflation over the next decade.

In other words, history tells us that the extreme duress of double-digit inflation was needed to inspire a change in the Fed's behavior...

The Fed eventually shifted to a more aggressive policy. It wound up shoving its benchmark federal-funds rate up to roughly 20% in March 1980.

But even then, it took time for the Fed to completely change its behavior...

It thought the job was done, so it dropped the fed-funds rate back to 9.5% by June 1980. Three more tries at 20% – in December 1980, January 1981, and May 1981 – were needed before inflation backed off enough for the Fed to declare its mission accomplished...

That chart looks like a screen from Super Mario Bros. It shows that the Fed clearly had no idea what it was doing. It didn't really know how long to keep rates at 20%.

I'm not saying it could have known. But that's a discussion for another day. The point is...

The Fed never admits it doesn't really know what it's doing – despite the fact that it's obviously just playing video games with our wealth until the economy says "game over."

And it's worth noting that a brutal recession stretched from July 1981 to November 1982.

When the Fed abandoned the 1974 low-interest-rate status quo, it shifted the status quo...

It pursued what today's Fed would call "highly restrictive policy rates."

And fighting inflation became the new status quo for more than a decade.

Then came the Japanese mega-bubble... the U.S. savings and loan crisis... the Long-Term Capital Management crisis... the dot-com bust... the 2008 financial crisis... the European debt crisis... and finally, the COVID-19 pandemic crash of March 2020.

Just like that, the old status quo of easy money and lower rates was back and bigger than ever.

So when rising inflation finally showed up in 2021, the Fed didn't recognize it.

Instead, Fed members twisted themselves into half-baked pretzels trying to justify their inaction. Do you remember how Fed Chair Jerome Powell and his buddies called inflation a "transitory" effect of post-pandemic reopening?

Whoops.

As I told The Ferris Report subscribers in this month's issue...

Inflation took off on a steep trajectory starting around February 2021. It hit a 40-year high of 6.8% in November 2021, but the Fed didn't start hiking rates until March 2022...

It took several months of extreme duress before the Fed even acknowledged the issue. And then, it took a few more months for the Fed to begin its most aggressive rate-hiking cycle since Paul Volcker roamed the halls of the Eccles Building.

I'm not saying that the Fed can or should fight inflation with interest-rate policy. Regular readers know I don't think the Fed should even exist.

I'm just saying that the Fed is like most human groups and individuals. It won't change what it's doing until the pain becomes unbearable.

And no matter what you think about inflation peaking and the Fed backing off, the pain hasn't become unbearable. So the Fed won't change what it's doing yet.

Here's another point worth making...           

Like it did in the 1970s and early 1980s, the Fed might do nothing for a meeting or two this time. The Fed members might just sit on their hands. But don't be fooled...

The Fed is like a blindfolded man throwing darts at a wall with a few balloons randomly taped onto it here and there. Its goal is to keep throwing darts until it hears a pop.

Remember, retail investors are committing a record $1.5 billion a day to every publicly traded piece of garbage they can get their hands on. As long as that keeps happening, there won't be any duress, any pops, or any changes of the status quo from them or the Fed.

This brings me to a revelation I had recently while recording the Stansberry Investor Hour podcast...

After interviewing probably 200 different folks on the podcast since 2018, I've noticed something... Every professional investor and trader winds up saying the same thing.

They wind up saying that risk controls are paramount. And notably, that's the opposite of the retail traders, who focus solely on all the money they think they'll make any minute.

I recently interviewed poker champion and author Annie Duke about her latest book, Quit: The Power of Knowing When to Walk Away. (The episode will publish next week.)

Part of the reason people don't stop what they're doing to do something else is simple...

Quitting has a bad reputation. And research suggests we're just not wired to do it...

In a section called "Waiting Until It Hurts," Duke reports on a 1975 study published by two psychologists. According to Duke, the psychologists wanted to answer two questions...

How long will people wait for something that never arrives, and what price will they pay to continue waiting? If turns out people will wait a surprisingly long amount of time, and they will pay an amount that clearly exceeds the value of what they were waiting for...

There are all sorts of ways we get stuck in our decisions. Presented with the opportunity and the relevant information, we will over-persist, rejecting the chance to quit and backing up our original decision by spending even more resources to try to save the endeavor.

The retail investor's endeavor is similar to a gambling addict... Stay in the game, come what may.

The institutional investor's endeavor is to stay in the game as long as he doesn't get fired.

And the Fed's endeavor is to keep the status quo until the American people suffer so much financial pain that it needs to do something to avoid a societal meltdown.

Retail investors still have enough money to keep placing their bets. Institutional investors still have their cushy Wall Street jobs. And the economy hasn't destroyed enough lives for the Fed to feel like it needs to change what it's doing.

But that won't last forever...

Retail investors will stop buying when they're wiped out. Institutional investors will stop gathering assets and taking your fees only when you fire them out of your life forever. And the Fed will pursue a new status quo only after you and your neighbors are soaking torches in kerosene and making effigies of Jerome Powell to burn on the White House lawn.

The typical talking head acts like every data point means something new, exciting, and very different is about to happen. But it's almost never true. And the data is nearly 100% noise.

They're only acting that way because they're paid to make all this boring finance stuff seem exciting. It's not, trust me.

So despite the constant noise in the press, it means nothing that the Fed's last two rate hikes were smaller than the previous four. 

Before we wrap up today, go back and look at the Volcker-era chart of the fed-funds rate...

It was all over the map, even though inflation burned hot the whole time.

They were trying out a brand-new status quo. And they had to throw several darts at it before they got the desired pop.

So I wouldn't get too excited about the idea that inflation has peaked. As I said last Friday, it's the dumbest narrative I've ever heard in my life.

And I wouldn't spend too much time pretending you have any idea what the Fed will do. We don't get to know that.

We just get to know that they're humans like the rest of us.

And as we've learned, humans don't like to change unless they're under extreme duress.

New 52-week highs (as of 2/23/23): Comfort Systems USA (FIX), indie Semiconductor (INDI), Madison Square Garden Sports (MSGS), MYR Group (MYRG), and Flutter Entertainment (PDYPY).

In today's mailbag, feedback for Stansberry Venture Technology editor Dave Lashmet, who wrote here about developments in the defense sector over the past two days. (If you missed Dave's contributions, you can catch up here and here.) Do you have a comment or question? As always, e-mail us at feedback@stansberryresearch.com.

"Thank you for your e-mail [on Thursday]. I've been considering a 'defense stock' homemade ETF. Your timing is everything." – Stansberry Alliance member Bill B.

"I really appreciate reading Dave Lashmet's Venture Technology newsletter. I have been reading it for at least six years and his Nvidia pick in 2016 was extraordinary. I find his research to be fascinating, especially with new and smaller companies." – Stansberry Alliance member Steve H.

Good investing,

Dan Ferris
Eagle Point, Oregon
February 24, 2023