Pump and Dump?

If the title of this post is a mystery to you, let me explain:

A pump and dump operation is a fraudulent manipulation of asset prices, usually individual shares, to make a large profit from naïve investors.

Essentially, the fraudster will buy a large number of shares that are cheap because the investee business is practically worthless. They then use a variety of illegal or shady methods to increase the price. These will usually include a hard sell over the telephone to vulnerable investors with a fake story attached, placing sales with friends who will sell out later and inventing news. As demand for the shares increases and the price starts to move rapidly because the fraudster may own a large part of the total shares available for sale but only actually sells a moderate amount at this stage, more and more greedy participants can be persuaded to enter the market.

When the fraudster has unloaded enough shares to drive the price up to an implausible level, he or she and friends will rapidly sell off the large remaining stock they have. A drop in the share price initially as liquidity improves may even make unwise buyers think they are now getting a bargain!

The fraudsters bank a large profit and the share price collapses very fast, leaving many inexperienced investors with shares that are almost impossible to trade and therefore worth very little.

I mention this now because it feels to me like global stock markets are operating such a wheeze right now, albeit collectively and without a fraudulent intent.

I suggest this because global equity markets, those investing in company shares, have risen to levels last seen in the mid Autumn and seem to be heading relentlessly up. But there is no change in the global economic climate to justify this. In fact most real news is negative and many of the underlying risks are actually greater.

Many commentators are struggling to explain what element of the combined human psyche is responsible. Some say that the US and China are bound to do a good trade deal. Others say that the likelihood of the UK crashing out of the EU is reduced (although for the life of me, I can’t follow their logic). Others say that although profits are beginning to shrink and dividends might slip back, this is only happening slowly and basically ‘everything is all right’. Some point to central banks being rather worried, so potentially slowing rate rises (that is good news?!)

My feeling is that we have a situation that might be equated to the mindset of a gambling football supporter betting on his or her usually top flight team winning a major competition when they have managed to make it through the early rounds, even though the manager has just been sacked, the best players sold off and until a recent cup run, this year’s league results have been pretty rubbish. Because such a person needs a boost to justify their support, they will bet on the win. The idea of a loss after several years of glory is just too depressing. I think many stock market participants are talking up the market because the alternative is just too gloomy to contemplate.

This is worrying, because if there is a correction back to a new harsher reality, the big players will take their money off the able in a flash, at their pumped up prices, and we small investors will be left holding a lot of assets that have just been dumped. Time to increase cash weightings further? Personally, I think that would be prudent for anyone who does not cope well with short term volatility – and that will be most people.