National Post (National Edition)
What's behind the surge in retail investor interest and will it last?
Three reasons that can explain the jump
Retail investors have played an increasingly large role in financial markets of late, spurring questions about what is driving this phenomenon and whether it's sustainable.
From our standpoint, we see three key catalysts as being responsible for the increased interest: a move to commission-free trading; a general lack of activities during lockdown; and government stimulus cheques. Together, these forces created a perfect set-up for greater retail participation, a dynamic we think will at least partly be enduring.
The broker model really began to change in 2013 when Robinhood Markets Inc. entered the United States market and offered zero-commission trading to investors. However, this business model became more widely accepted in late 2019 when six of the largest brokers — Interactive Brokers Group Inc., TD Ameritrade, Charles Schwab Corp., E-Trade Financial Corp., Fidelity Investments Inc. and Ally Invest — all announced they were dropping commissions on stock trading. Clearly, this announcement had the effect of lowering costs for smaller investors (something that had, up until then, been reserved for much larger clients), thereby encouraging more frequent trading. This set the stage for greater retail interest.
As governments rushed to contain the COVID-19 pandemic, enforcing lockdown measures in the process, there was a general dearth of entertainment opportunities (there are only so many shows you can watch on Netflix). This, coupled with large price swings due to heightened market volatility, boosted the appeal of stock trading to individuals in need of some excitement. This is shown pretty clearly by Google data showing that searches on “buy stocks” shot higher in March 2020, reaching levels never seen before.
The stimulus cheques added fuel to the fire: investors who were gaining familiarity with trading platforms, learning how to buy and sell stocks, and seeing pretty well everything they owned go up in price (after the U.S. Federal Reserve fired its bazooka and put a bottom under the market) suddenly had extra cash to play with. A survey conducted by Deutsche Bank found that respondents (retail traders) put roughly 40 per cent of any payment they received from the government into the stock market.
Together, these forces have drastically increased retail participation. Retail investors now account for 24 per cent of equity volumes, up from 15 per cent at the end of 2019, according to Bloomberg Intelligence. This compares to 27 per cent for institutional investors, so clearly the impact of small traders has become too large to ignore.
This brings us to the recent “meme stock” phenomenon, which is a byproduct of greater retail trading. In essence, these stocks tend to see much greater-than-normal volatility due to heightened retail interest fuelled primarily by individuals on social media (Reddit, Twitter and Tik Tok). These investors are generally operating with very small sums, nowhere near enough to move markets on their own. However, collectively, their buying power is substantial, especially when it is focused.
Without a doubt the poster child for the meme stock phenomenon is GameStop Corp., a struggling videogame retailer that was previously among the most heavily shorted. Members of a Reddit forum — wallstreetbets — openly discussed buying the stock en masse, which would force shorts to cover their positions (hedge funds were their prime target), leading to a big rally in the stock. This strategy worked: the stock traded at US$19 per share at the start of the year before eventually hitting an all-time high of US$483 on Jan. 28. A number of hedge funds suffered large losses as a result of the parabolic move — Melvin Capital Management LP, as an example, required a US$3-billion injection from Citadel LLC and Point72 Asset Management LP to shore up its finances.
Data from Subreddit Stats indicate that there were roughly 1.9 million subscribers on wallstreetbets at the start of January 2021 before jumping to more than nine million at the end of that month. This coincided with the increased attention that GameStop, and other heavily shorted names such as AMC Entertainment Holdings Inc., received. Subscriber growth has since slowed — as of June, the number stands at 10.5 million — but a formidable retail army (since these individuals tend to act in unison) has been formed.
As it stands, the meme stock phenomenon has cooled off from its peak interest in January. This can be shown by the marked decrease in comments on wallstreetbets — from nearly 400,000 per day in mid-January to roughly 15,000 currently. Perhaps this can be traced to more opportunities for entertainment (as the economy has opened) or, alternatively, maybe there just isn't an investment story that has captivated the retail crowd. Nonetheless, the sheer number of subscribers on wallstreetbets suggests there is the potential for these individuals to exert a massive influence on financial markets again in the future.
Looking forward, two of the three catalysts for heightened retail participation (a lack of entertainment activities and government stimulus cheques) will no longer be a source of support. But commission-free trading is here to stay, which will keep retail demand higher than in the past. As such, we believe it will be critical to monitor this segment of investors — their influence on financial markets is substantial, but can often be unpredictable (as hedge funds on the short side of GameStop can attest). From our standpoint, we think it's best to avoid the stocks that garner the interest of the meme stock crowd and stick to names that are better supported by fundamentals (as opposed to speculation).
Join me on Webcast with Dave on July 14, when I will be hosting Stephen Roach, senior fellow at Yale University's Jackson Institute of Global Affairs and former chair of Morgan Stanley Asia. Learn more at rosenbergresearch.com.