The Amplification of Market Noise

Market noise has always been a distraction, but social media platforms have amplified the noise and regulators are now asking questions about what this means for market integrity. Elon Musk’s plans for Twitter might exacerbate this issue.

In October last year, the Securities and Exchange Commission (SEC) in the United States released a report about the impact of meme-stock trading on the integrity of the stock market.

A meme-stock, according to Investopedia, typically refers to the shares of a company that have gained a ‘cult-like following online and through social media platforms’.

“These online communities can go on to build hype around a stock through narratives and conversations elaborated in discussion threads on websites like Reddit and posts to followers on platforms like Twitter and Facebook,” Investopedia says.

Although there are several examples of such stocks, the SEC takes the case of GameStop as an illustration of the problem.

In January 2021, the share price of GameStop experienced a dramatic increase as individual investors took to social media praising the prospects of the company. The share price of the company went from less than $20 in December of 2020 to $325 at the end of January.

In response to the extreme volatility, several retail broker-dealers temporarily prohibited certain activity in the stock and related options, raising questions about the integrity of the market structure in the US.

In the conclusion of the SEC report, one can almost feel the frustration of the regulator with this episode.

“Underneath the memes are actual companies, with employees, customers, and plans to invest in the future. Those who bought GameStop became co-owners of a company through a system of mutual trust and participation that sustains our economy,” the regulator writes in the report.

“People may disagree about the prospects of GameStop and the other meme stocks, but those disagreements are what should lead to price discovery rather than disruptions.”

The turmoil caused by a group of investors egging each other on on social media platforms has had a profound impact on the regulator’s thinking.

The SEC has now committed to taking a closer look at forces that may cause a brokerage to restrict trading, digital engagement practices and payment for order flow, trading in dark pools and through wholesalers and short selling and market dynamics.

As such, Billionaire Elon Musk’s US$ 43 billion bid for Twitter (“I can afford it”) last week and his motivation to take the company private could form an important obstacle in the regulator’s bid to stem volatility caused by groups active on social media platforms.

Several hours after Musk declared the offer, he was asked about the reason behind the move during a TED interview in Vancouver.

Musk answered by stating concerns about free speech on the platform and promising more insight into the decisions made by Twitter’s algorithm as to which tweets get promoted and which users are restricted.

Musk has been described as a ‘free speech absolutist’, and seems to be of the view that delusional or harmful opinions should simply be countered with more opinions.

“Twitter has become kind of the de facto town square, so it’s just really important that people have both the reality and the perception that they are able to speak freely within the bounds of the law,” Musk said during the interview.

His motivation to take Twitter private also seems, at least in part, to be a response to cancel culture and wokeness in the US, which Musk considers avenues to block dissenting opinions.

“At its heart, wokeness is divisive, exclusionary, and hateful. It basically gives mean people a shield to be mean and cruel, armoured in false virtue,” he said recently in an interview with The Babylon Bee, a conservative, satirical website.

It goes beyond the scope of this column to address the culture wars in the US, but an unconstricted Twitter could potentially have consequences for the level of noise in markets and subsequently increase stock market volatility.

Arguably, the problem with meme-stocks is not so much one of market integrity, but rather of amplification.

Investment clubs have been around since at least the 1800s, and most likely much earlier. Investment forums can, to some degree, be seen as an extension of this phenomenon, even if the participants in these forums don’t pool their money.

As with investment clubs, investors flock to these forums to learn about investing, gain insights and share a passion with likeminded people.

But whereas the clubs of the past had limited reach and operated often behind closed doors, today’s investment forums play publicly and on the world stage through social media platforms.

These platforms help amplify individual investor’s opinions to reach vast audiences across many jurisdictions, and, as we have seen, sometimes with dire consequences.

Is this something that can be reversed, or is the genie out of the bottle? I tend to lean towards the latter.

For Australian pension funds, this is an important question to consider as domestic regulations penalise tracking error with APRA benchmarks and so an increased volatility of the underlying market poses a problem.

Perhaps, institutional investors will see this as yet another argument to increase their allocation to private markets.

Wouter Klijn

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[i3] Insights is the official educational bulletin of the Investment Innovation Institute [i3]. It covers major trends and innovations in institutional investing, providing independent and thought-provoking content about pension funds, insurance companies and sovereign wealth funds across the globe.