By Justin Spittler, editor, Casey Daily Dispatch
How do you know when the market’s topped?
Some folks say it’s when stocks get insanely expensive. Other investors say it’s when “irrational exuberance” takes hold. That’s when investors buy stocks without thinking. They assume nothing can go wrong.
These are both classic signs of a top. But Bank of America has been waiting for a different kind of red flag. The banking giant wrote in a research note last month:
You’ll know it’s the “big top” when millennials start buying.
Millennials, as you probably know, are people born between the early 1980s and early 2000s.
They’re known for loving brunch, shopping at Whole Foods, and taking selfies. But one thing they aren’t known for is buying stocks.
Some people will say this is because millennials don’t have any money. That they’re still living in their parents’ basement. Others will say it’s because they spend too much money on lattes and avocado toast.
• In any case, millennials have mostly sat out the stock market in recent years…
But that’s starting to change.
These days, millennials are opening trading accounts left and right. They now make up 40% of all new accounts at TD Ameritrade, one of the largest U.S. brokers.
That alone doesn’t worry me. But I’m very concerned about what millennials are buying…
It’s not blue-chip stocks. It’s bonds. It’s derivatives.
Victor Jones, director of trading and operations at TD Ameritrade, explained in a recent interview with Business Insider:
“Trades from mobile tend to be more futures-based,” Jones said. “More people are gravitating towards derivatives like options and futures.”
Derivatives are exotic financial instruments. They derive their value from stocks, bonds, or even interest rates.
If the term sounds familiar, it’s because derivatives were extremely popular on Wall Street a decade ago. They’re why a housing crash in the United States turned into a global financial crisis almost overnight.
They aren’t for the faint of heart.
• Yet, millennials are trading them like hotcakes…
Derivatives trading now accounts for 45% of TD Ameritrade’s transactions. That’s up from 10% in 2009.
Other brokers have also seen huge spikes in derivative trading.
In fact, a recent study by E-Trade found that 40% of millennials are executing at least one option trade per month.
Some of these people are trading options for income. But about 35% of these millennials are trading options to create leverage. In other words, they’re making risky bets with options in hopes of making outsized returns.
As if that weren’t concerning enough, many millennials are trading derivatives around the clock. Jones told Business Insider:
When you have your phone on you, you’re available to look at the markets 24/7, but the markets aren’t open 24/7… Futures give millennials or any investor the opportunity to participate in the market 24/7.
This is a serious red flag.
It tells us that there’s so much greed in the air right now, millennials feel like they have to trade around the clock. Otherwise, they might miss their chance to get rich.
• This is the type of behavior you only see at the end of booms…
We saw the same sort of thing happen in 1999.
Everyday investors blindly piled into high-flying internet stocks. A few months later, the market topped out. The average internet stock went on to plunge 79% over the next two and a half years. Many former internet darlings like Pets.com went to zero.
The same thing happened in the housing market in 2007.
That time, people borrowed huge sums of money to buy homes they couldn’t afford. When the market turned, those folks took huge losses. Many people even lost their homes to foreclosure.
Housing prices eventually fell so much that it triggered a global financial crisis. The average U.S. stock went on to plummet 57% over the next year and a half.
Today, we’re seeing the same sort of reckless behavior. Only this time, it’s millennials gambling on futures and options.
• You’d be a fool to ignore this warning sign…
So be sure to take precautions if you haven’t already. Here are three ways to get started:
Sell your weakest positions. Start with your most expensive stocks. From there, get rid of companies with weak balance sheets. If the market runs into serious problems, companies with a lot of debt and little cash will be put to the test.
Set aside extra cash. Holding more cash than usual will prevent you from suffering huge losses when the market turns down. It will also provide you with “ammunition” to pick up great stocks at cheap valuations.
Own physical gold. This is one of the simplest ways to protect your wealth from catastrophic losses. After all, gold’s the ultimate safe-haven asset. It can rise while everything else is falling. To learn more about gold and the best ways to add some to your portfolio today, check out our free report: The Gold Investor’s Guide.
These simple steps will prevent you from taking huge losses should stocks soon top out.
Delray Beach, Florida
July 5, 2017