The Dark Side of Social Media and Stock Market

This is the clip that went viral on social media a few months ago. Cristiano Ronaldo removed the Coca-Cola bottle from the desk during a press conference. As a result of this action, Coca-Cola lost $4 billion in valuation. Similarly, in 2018, Kylie Jenner, a social media icon, wiped off Snapchat’s valuation by 6% with her tweet. You might not find it surprising as Coca-Cola and Snapchat could’ve suffered losses to their business because of the bad publicity. Even though it sounds plausible, it’s not true.

Both Coca-Cola and Snapchat saw no losses on the business due to these incidents. The reason behind the change in the stock valuation of these companies was just viral videos and tweets. Now you may think how does social media impact the stock market? The fact is the stock market isn’t always liked with the company’s fundamentals. Other factors play a crucial role in the determination of the stock valuation of a company. Stock market expert, André Kostolany, says that facts only account for 10% of the reactions on the stock market. The rest can be attributed to psychology. And without any doubt, social media plays a pivotal role in molding the psychology of the general public.

Seeing the demotion through Jenner’s tweet or Ronaldo’s, investors panicked just on the assumption that others would sell their stocks. With the speed with which social media can change things, many have argued that it can lead to a stock market bubble. And if this bubble bursts, a lot of lives may be impacted. Now before we try to understand how social media create a stock market bubble, we need to understand two things. First, let’s try to understand what a stock market bubble is. When stock prices increase very quickly due to high demand which cannot be justified by fundamentals, the market is said to be in a bubble. ‘Fundamentals’ is a technical term that indicates the growth of a certain company or an economic sector. If the fundamentals of a company are doing well, we can say that the company’s stocks are valuable.

To understand this better, we must differentiate between Stock Price and Stock Value. Many people confuse the two and it’s really important for us to understand the difference. The stock price represents how much the stock trades at—or the price agreed upon by a buyer and a seller. If there are more buyers than sellers, the stock’s price will climb. If there are more sellers than buyers, the price will drop. On the other hand, the stock value is the intrinsic value of a company that depends on its fundamentals: its profits, the growth potential of its sector, and the country in which it operates. The second question: is Indian in a stock market bubble? Many experts have voiced their concerns over the possibility of a global stock market bubble.

In its annual report for 2020-21, RBI noted that increase in the stock market while the economy was performing poses a risk of a bubble. The price-to-earnings (PE) ratio of the Sensex, a ratio used to judge the value of the stocks, during the current financial year has stood at 31.6. This basically means that investors have been paying ₹31.60 as a price for every rupee of earnings of the 30 stocks that form the BSE Sensex. For perspective, the PE-ratio level is higher than that of June 2000, when the dot-com bubble. It is also higher than the stock market bubble of 2007.

Apart from that, Buffet indicator, named after the stock market legend Warren Buffet, is also used. It is the ratio of Market capitalization and GDP. It currently stands at 1.04 in comparison to the long-term average of 0.79. Now the challenging part is that no one really knows when a stock market is in a bubble. You can only tell when it bursts. But we can understand how it’s caused. So I would like to point out two reasons how social media causes a stock market bubble.

Nowadays, people rely on social media to not only connect with their friends and family but to gather information. A Fidelity survey in the US earlier this year found that 42% of Gen Z respondents were “most likely to say that they turn to social media influencers to educate themselves on investing.” But this has a flip side which is called a network effect. The network effect is a phenomenon whereby increased numbers of participants improve the value of a good or service. Let’s understand it through this statement made by Nithin Kamath in an interview with Fortune India. “I don’t know what is moving the market. The news is bad; the fundamentals are bad.

People are buying because the markets are going up, and the markets are going up because people are buying.” The reason behind the rapid growth of the stock market is the investment made by buyers of the same stock. This is the best example of the network effect. Is this a problem? Yes! In July 2020, a relatively unknown TikTok user made a video appeal to pump the ‘joke’ cryptocurrency Dogecoin. He urged that if everyone on TikTok bought into the cryptocurrency they would all get rich. This caused the trade volume of Dogecoin to spike by 1000%. Many earned profits by investing in Dogecoin but many suffered losses. This shows that to take full advantage of stocks or cryptocurrencies, you need to do extensive preparation and research.

This is not only true for financial markets but also for the labor market. For example, recently there has been a big spike in the demand for data scientists. Last month’s article on Livemint reported that data scientists are in huge demand and there are not enough of them to fill vacancies. But students and professionals will be able to take advantage of this only if they’ve got the right skills. We were discussing that the network effect can inflate the value of assets not because their fundaments have increased but because people have started to value them more. Everyone enters with the assumption that there will be someone who will enter after them and to whom they’ll sell their assets. But this strategy doesn’t work all the time. According to Bloomberg, 50 meme stocks added $276 billion in value in a year. However, in just a matter of days, $167 billion had been wiped out. As a result, many retail investors lost their life savings.

In addition, social media can lead to a herd mentality where people act on information without carrying out research of their own. In January 2021, Elon Musk made a simple two-word tweet: “Use Signal”. This lead to people investing in a small medical device named Signal. The company experienced a gain of 12,000 percent in its stock price in just three days. The second reason how social media creates a stock bubble is that most of the users of these platforms are youngsters who don’t have much experience in investing. Apps like Robinhood in the US have democratized investing for the youth. There are similar apps in India as well, which led to the rise in the number of Demat accounts. People have also started to follow ‘financial gurus’.

This practice could be beneficial but it could also lead to social trading. Social trading is a form of investing that allows investors to emulate the experts. But this strategy works only if the so-called expert is a real expert. And that’s not the case always. The traders repeat mistakes committed by the experts. Social trading is especially dangerous in countries where the financial literacy rate is low. According to a global financial literacy survey, India ranks the lowest amongst the other emerging economies in terms of financial literacy. This can lead to people committing basic trading mistakes. We tried hard to find an example from India but unfortunately, we couldn’t come across any.

Instead, we came across an example from London which encapsulates the lesson. Noor, a designer in London, earned profit owing to the social media hype around Bitcoin in Nov 2020. She began to invest in the stock market using the profit. She relied mainly on a YouTube channel, a discord group, and an infamous subreddit ‘wallstreetbets’. She said she joined these groups for socialization but soon they became the highlights of her day. She repeatedly checked her phone to get new insights on her portfolio. Soon after the Game Stop and cryptocurrency crash, Noor lost £23,000. But at least she was aware of the limitations of her behavior. She admitted that she’s impatient, which isn’t a good trait for being a stock investor.

During the interview, the interviewer discovered that Noor could use some financial terms but she didn’t know what they meant. She watched the film The Big Short, but couldn’t explain what shorting was. She bought stock depending on internet hype, or how she was feeling on the day. And social media can easily influence these feelings. Some governments are actively trying to take measures against this issue. For example, Nasdaq in the US is working with a German data analytics company to curtail market manipulation through social media. The long-term solution is to increase financial literacy in our country. In India, Sebi has launched a program called SMARTs to educate investors.

Garg, the executive director of SEBI said India has close to 80% literacy rate but only 27% of Indians are financially literate. And the SMARTs program is free for the public and can be accessed from anywhere in the country. Perhaps even private companies can help offer such courses. We talked about the risk of social media in the video but many experts argue that social media may not have a long-term impact on the stock market. R Kalyanaraman, CEO of a brokerage firm said, “I am not totally convinced that social media can have a huge impact. “He’s unsure about social media creating a stock market bubble.” It’s true that the relationship between social media and the stock market is quite a novice and there’s no extensive research on it. And R Kalyanaraman could be right when he said that social media can only have a short-term impact on the stock market. Though this question is invaluable to those who trusted social media and lost their savings.

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