How will spike in retail investment end?

The late US president John F Kennedy has been quoted as saying, “The Chinese use two brushstrokes to write the word ‘crisis.’ One brushstroke stands for danger; the other for opportunity. In any crisis, be aware of the danger – but recognize the opportunity.” Omitting the fact that the translation was incorrect, 2020 has proved Kennedy’s words. 

After the 2020 economic crash, thousands if not millions of investors have entered the market for the first time. A spike in new brokerage account openings has been registered not only in the US but all over the world, including Russian and Japan. The reason is simple: People saw a unique opportunity to buy cheap stocks with good long-term prospects. 

Curiously, this time it wasn’t so much about the big sharks, but retail investors who have never traded before. According to Credit Suisse, since the start of 2020, retail trading as a share of overall activity has nearly doubled from between 15% and 18% to more than 30%.

It is worth mentioning that their focus of interest wasn’t only stocks, but also options trading. At the largest e-brokers, 32.7 million contracts traded on all the equity options exchanges in December.

What else attracted new investors?

Overall, the widespread adoption of zero-fee trading by the brokerage industry, the growing popularity of mobile trading applications such as Robinhood, a loss of various entertainment options, and stimulus money have set the bar to entering the investing world significantly lower for retail investors. 

Did retail trades move markets?

As the number of retail-minded market participants grew, so did their effects on daily trading activity. As CNBC’s Jim Cramer said, young investors “changed the entire character of the market.” At the same time, the rise of retail has helped to fill the void left by lower corporate buyback activity. 

Nevertheless, according to an IHS Markit study, while retail activity has seen a year-to-date increase with varied impacts by sector/market, the cohort remains too small to be considered a primary driver of equity price movements. Institutions and hedge funds remain the key drivers of market-wide activity.

The data also suggest that after the equity market crash in early March last year, retail investment in travel and tourism-related stocks, particularly airlines, hotels, resorts and cruise lines, soared as retail investors looked to “buy the dip” and speculate on a quick recovery in the sector.

Still, this doesn’t mean that amateur investors are irrelevant. And the case with GameStop clearly proves it.

In a matter of days, traders from the subreddit “WallStreetBets” managed to push the company’s stock from US$18.84 at year-end 2020 to $325 at the close on January 29, 2021. At year-end, GameStop was the 314th-largest stock in the S&P SmallCap 600. By the end of January, it had risen to No 1. GameStop had been heavily shorted by hedge funds, and its rise was partly fueled by retail traders hoping to profit from a short squeeze.

It is also true that without continued demand, GameStop shares couldn’t stay up, falling back to $52 levels. Overall, GameStop has been an interesting phenomenon among small caps, but without great significance for the market as a whole.

Finally, we should keep in mind that the Reddit effect is not something new. In the late 1990s, Internet chatrooms dedicated to stocks also helped sustain the tech bubble. The only difference with current social-media platforms is the magnitude. Additionally, Reddit helps commission-free trading and provides easier ways to dabble in risky instruments like options.

What could happen when the bubble collapses?

All stock-market bubbles eventually burst, and this one will not be an exception. The only question is how retail investors will react to a sharp decline in stock prices.

As a result of the 2008 financial crisis, Americans became deeply skeptical about Wall Street and its network of brokers, fund managers and retirement advisers, and even the fairness of the securities markets themselves. Something similar happened after the Japanese bubble burst, which pushed retail investors away from stocks for years.

In the present case, most probably the market will continue growing as long as the fear of missing out remains in place. Even though recent surveys suggest that an asset price bubble will be the biggest risk for the next three to five years, there are fears that the recent stock price rally has stretched valuations too far, particularly in the US.

Deutsche Bank, in particular, found that Bitcoin and US tech stocks are seen as the biggest bubble risks. Some believe that valuations of equity indices look more reasonable if we consider the backdrop of low interest rates.

In conclusion, it is hard to say how retail investors will react to a bubble burst, but on the good side, we could mention that many if not most retail investors take a long view. Thus, even if the market falls, most of them will probably keep their money in the market and think of a long-term return.