Individual investors are back – here’s what it means for the stock market

See who’s left.

After a long absence, active individual investors have returned. While a violent and foolish trading activity with shares in GameStop Corp.
GME,
+ 2.54%

has dominated the headlines, unanswered questions remain as to whether a broader retail boom will last and what it will mean for the stock market as US benchmark indices march to ever-higher levels.

It has been a long time coming.

The stock market had a historic rally over the last decade “without any prominent retail interest in it,” Chris Konstantinos, chief investment strategist at RiverFront Investment Group, said in an interview.

He noted that total bond fund flows have exceeded stock flows by nearly $ 3 trillion since 2007. In fact, individual investors seemed interested in just about everything else, from real estate to cryptocurrencies, Konstantinos said.

A shift started last year when the coronavirus pandemic took hold. Sequential growth in accounts with brokers such as Charles Schwab Corp.
SCHW,
+ 4.04%

meeting individual investors “was remarkable” at the end of the second quarter of 2020 and was followed by strong growth in the following quarter, said Lori Calvasina, head of the US equities strategy at RBC Capital Markets, in February. 2 note.

At the same time, Google searches for “day trading” were also increasing, she noted (see charts below).

RBC Capital Markets

Calvasina and others acknowledged that a combination of lockdown-related boredom and stimulus control from the U.S. government likely played a role in the rise in individual investment interest.

The jury is out on whether this enthusiasm will endure, said Ed Clissold, chief executive of the United States at Ned Davis Research Group, in an interview. It is unclear how much of the pickup in retail simply reflects individuals throwing extra money through stimulus control in the market, he said.

That kind of trading feels more like gambling than investing, he said, noting that “frothy” market actions tend to fade away quickly.

Need to know: GameStop’s meteoric gains have almost completely disappeared – here’s advice for those who did not come out on time

No doubt day traders who jumped on the GameStop rally big and listened to pleas on Reddit’s WallStreetBets forum to keep the line were allowed to suffer ugly losses. Some market watchers fear that the bubble-like activity in so-called meme stocks could end up scaring individual investors away and sipping any resurgence in the bud.

See: ‘My family will not let me go hungry’: Two young traders reveal the dangers of trying to surf GameStop’s epic wave

But others argued that many individual investors, whose ranks do not consist of fast-trading daily traders, would likely hold on.

‘Structural change’

Calvasina said the RBC suspects that “structural changes may be underway and that retail investors are likely to continue to be major players in the U.S. stock market.”

In that case, it will require an attitude adjustment by Wall Street professionals who became accustomed to paying a little attention to individual investors.

After all, powerful waves of passive and systematic investment had made individual investors largely irrelevant to analysts who boiled market forecasts, strategists at Société Générale wrote in a Thursday conference.

But the market volatility created by the GameStop situation served as a wake-up call, analysts said.

While GameStop and other much shorter names rose, hedge funds and other investors liquidated long positions elsewhere to take profits and cover losses and put pressure on stock markets. Major benchmarks ended January on a sour note with the Dow Jones Industrial Average
DJIA,
+ 0.09%
,
S&P 500
SPX,
+ 0.47%

and the Nasdaq Composite
COMP,
+ 0.50%

log their biggest weekly drop since October.

US stocks roared back in the past week, however, with the S&P 500 and Nasdaq scores full-time heights when GameStop tumbled more than 80%.

SocGen analysts said increased retail interest in the markets is part of a broader trend that has seen individual investors drive demand for investments that take into account environmental, social and corporate governance or ESG standards.

“Instead of criticizing retail investors and their behavioral teats, it is better to place them in the money equation,” they wrote. “After all, it’s not only office workers who are locked up at home on snowy days, but also very active day traders with access to cheap platforms.”

However, cabin fever is hardly the only factor driving the renewed interest of individual market investors in the market.

Leveling the field

Some individual investors who previously avoided equities may finally succumb to the notion that ultra-low interest rates on bonds and elsewhere leave little alternative to the stock market. Equities still look attractive when it comes to dividends or earnings yields, Konstantinos said.

In addition, there has been leveling of the rules of the game between institutional and individual investors over the last few decades. Regulation FD (for “full disclosure”) and other regulatory changes as well as the rise in low-fee trading platforms have put individual investors “closer to institutional investors than at any other time in history,” he said.

In fact, some market watchers have argued that the traditional branding of individual investors as “stupid money” looks more and more misleading, especially after the GameStop episode allegedly showed “smart money” investors shorting more than 100% of the company’s stock and leaving them open to a painful short pressure.

Calvasina noted that some of the more well-known trades that individual investors have been pursuing over the past year – buying stocks in the midst of a recession, buying airlines and cruise ships last summer and implementing short squeezes this winter – come from a playbook that has been largely abandoned by institutional investors over the past decade in favor of growth, momentum and quality investment strategies.

At that point, strongly short-circuited names have surpassed the market since the lowest on March 23, when it comes to both small and large stocks, a development that typically happens when the market has put a recession in the middle, she noted.

Still, the madness in retail that surrounded the short squeeze on GameStop, and a handful of other highly short-lived small-cap stocks, raised a red flag for investors looking for the kind of foam that signals a rally is about to go into that kind of euphoric phase. typically followed by a withdrawal.

Next stage?

While this may prove to be the case in the short term, some investors argue that a sustained pick-up in active individual investment interest can help drive the next leg in a bull market.

Individual investors could continue to create interest in more value-oriented, smaller assets and higher volatility names, Konstantinos said.

And sustained interest in individual securities could mean more “spread” or variation in returns between individual stocks and sectors, Clissold said – an element that was lacking over the past decade to the pain of active fund managers.

Calvasina argued that retail interest in specific stocks is likely to decline and flow, as it has done over the past year, but is unlikely to disappear.

“Unless the door is closed (ie through a major legislative change), we can not see why retail investors’ interest in trading with specific names will fully take into account how high cash on the sidelines is among consumers,” she wrote.

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