Novice investors’ use of apps is helping to shake up the markets
Life is all about opportunity and risk.
Wise people like to hoard the former and shove the latter onto others. In financial markets, skilled investors know that corporations sell stock to distribute their risk. That is why buying stocks is called the “risk-on trade.”
I’m not sure the millions of people who have started using video game-style phone apps to buy stocks realize that. But those first-time investors who took the opportunity presented by the Coronavirus Recession now are learning about the risk posed by September, the cruelest month for markets.
Ever since COVID-19 started making headlines in March, U.S. stock markets have behaved oddly, some might say perversely.
Indexes crashed when the world’s major economies began closing, and the inevitable recession became a reality. Over the past month, though, the broadbased S&P 500 Index and the tech-focused NASDAQ have hit record highs.
Even though corporate earnings are in the toilet and forecasts say gross domestic product will not reach 2019 levels again until 2023, stock market indexes rallied. At least until last week. The NASDAQ has dropped 10 percent since Wednesday’s close, the S&P is down 7.5 percent.
Economists and market watchers have many theories to explain the markets’ bounce to record highs. Stock prices reflect optimism about a corporation’s prospects after the pandemic, not the current reality. But another explanation is the influx of inexperienced investors using their phones to trade stocks.
The most noted stock trading app, Robinhood, has added 13 million accounts. Since March, trading on the app has tripled.
Robinhood’s interface makes trading stocks, options, cryptocurrencies and other financial instruments feel like a game. Not to mention, the trades are free, so you can trade a lot.
Add in traders sharing their choices on social media, and you
have a new force adding momentum to the markets. These new investors have focused on a handful of tech stocks, including Apple, Tesla and Amazon, which also are responsible for most of the gains in the stock indexes.
“Robinhood traders are attracted to stocks that are in the news, experiencing extreme returns and abnormally high trading volumes,” a J.P. Morgan QDS research note concluded. “Stocks with increasing popularity with Robinhood users outperform those with decreasing popularity in the next one week and one month. For longer horizons, the evidence is inconclusive.”
Well, welcome to September. Maybe it’s because summer is over and people are more steelyeyed heading into the end of the year, but historically September is the worst month for stock returns. Competitive presidential elections also add uncertainty, which leads many traders to sell and hold cash until the results are better understood.
Institutional investors also go risk-off when the economy contracts and the COVID Recession has been no different. Institutional investors have pulled tens of billions of dollars out of U.S. stocks every week since March, according to the Investment Company Institute, which tracks asset flows.
Money market funds, where
investors keep cash, are holding a near-record $4.5 trillion. Gold, a traditional haven, is near record highs, and bond funds are growing fast.
While Robinhooders and their allies bought the dip they saw as an opportunity, big investors dumped their risk assets.
Complicating matters is a sudden rise in options contracts. Options give investors the ability to buy or sell a stock at a specific price in the future. They are a way to gamble on future stock prices without actually buying the stocks.
Options trading is popular with the millions of people who bet on sports or fantasy sports leagues, which is one popular explanation for the surge in options activity.
Ultimately, the stocks backing
the options must be bought and sold, so the effect of people piling into the options has the same effect as people piling into stocks: share prices go up.
Retail investors using mobile apps to buy options are, therefore, indirectly driving up stock prices, and at least one big investor tried to ride their coattails. The Wall Street Journal reported last week that Japanese tech conglomerate Softbank capitalized on the momentum and bought a staggering $4 billion in options, enough to distort the market for tech stocks.
Between the mobile app traders and Softbank’s big gamble, the prices for a handful of tech stocks drove market indexes to record highs, even as long-term investors pulled their money out.
The recent drop in stock prices likely is the deflation of that bubble. How far it will deflate is hard to predict, since the problem is not with the companies themselves, but what Alan Greenspan called “irrational exuberance” over the value of those stocks.
Economist John Maynard Keynes liked to blame “animal spirits” when markets behaved oddly. Whether you see opportunity or risk in stock markets driven by hunches and bored amateurs really depends on whether you are a gambler or an investor.