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When regular life came to a screeching halt last March, many Americans turned their attention to trading stocks online, pouring billions into markets and helping drive stock prices to record levels. Now that the economy is starting to re-open many pros are wondering what happens if prices start to sink — or if these newcomers simply get bored.
“Once we get back to “normal,” will folks have time to be on their trading apps, and if not, what does that mean for the market?” says Pauline Bell, an equity research analyst at CFRA Research.
Not so long ago — 2019, to be exact — retail investors accounted for just 10% of the stock market’s total trading activity. The retail crowd’s share of the overall market more-than doubled to 25% in 2020 and neared 30% this year, according to estimates from Citadel Securities and Themis Trading.
Small traders have become “a much more powerful market force,” according to a February report from Goldman Sachs, which estimated that the dollar-value of retail trading (small-lot trades under $2,000) was up 85% versus 2020. And the companies that benefit most from the retail trading are cautioning that the good times may not last. As Charles Schwab put it in February: “Pandemic-level trading volumes are not sustainable.”
Even the people who are trading seem skeptical: Nearly 75% of stock investors believe the market is in a bubble, according to an April survey by E*Trade Financial.
Indeed, there are “hallmarks of a speculative bubble” in areas of the market, notes Robert Shiller. It’s a topic the Yale economics professor knows well; he wrote "Irrational Exuberance" at the peak of the dot-com market bubble. Unlike the late 1990s, when the Internet was generating genuine excitement about investing in stocks, the market’s current bout of irrational exuberance doesn’t have as sound of a basis, he tells Money.
While there are some obvious aspects of a bubble, like herd mentality, Shiller says he doesn’t know when or why the bubble will burst — and how bad it will be once that happens. “It’s hard to predict how public opinion will change.”
A potential snowball effect
Public opinion, or at least for now, remains pretty positive about stocks. In April, the percentage of retail investors who said they expect stock prices will be higher in the next six months reached a pandemic-era high of nearly 57%, according to a weekly sentiment survey conducted by the American Association of Individual Investors.
And there’s serious money to back up this bullishness. Exchange-traded funds, which are popular among retail investors, attracted more money — to the tune of about $250 billion — in January-April than all of 2020.
It doesn’t hurt that investors jumped into the market at a particularly good time: Both the S&P 500 and Dow Jones Industrial Average have notched dozens of record highs already this year.
But the good times inevitably won’t last, and AAII’s sentiment survey has proven to be a contrarian indicator in the past. For example, consider when bullishness was last as high as it was in April: Early 2018, just weeks before a market correction when the S&P 500 fell more than 10% and retail investors rushed to sell stocks.
The risk to the broader market, as Bell notes, is a selloff that snowballs if there’s a rush for the exits. What’s more, some traders won’t be able to handle volatility and will happily find excuses to step away from trading as other distractions beckon again, she adds.
“Everybody wants to invest in a market that’s going up because they look like a genius,” Bell says. “What happens if it’s down 20%?”
Can volatility be contained?
The notion that retail traders could cause a market selloff or worsen one may overstate their power, cautions Michael Antonelli, a managing director and market strategist at Baird. Just as it was impossible to foresee the rise of this new generation of market participants, it’s difficult to predict the next steps of millions of people, he adds.
Antonelli likens the retail crowd to partygoers — some arrive early, some arrive late, but they don’t typically leave at exactly the same time. People who spent the last year learning how to become long-term investors are more likely to stay invested than those people who are treating it like a game, he says.
Speculators with an abundance of time and money on their hands have been chasing returns in meme stocks, cryptocurrencies, SPACs, and NFTs, says Megan Horneman, director of portfolio strategy at Verdence Capital Advisors. But she views the risk of a change of heart as “more noise” than a broader market disruption. “You may see volatility in specific names and subsectors that attracted interest from speculative traders.”
Of course, what happens in one corner of the market can have a ripple effect. And the wave of money flowing into ETFs this year could just as easily flow out, and these funds do pose systemic risks to the market, as various researchers have concluded. In March 2020, however, these funds attracted net inflows, suggesting that ETF investors weren’t panic selling.
Finally, market dynamics could limit the power of retail traders. And just as they don’t deserve credit for the S&P 500’s rally of as much as 88% from its 2020 low, they won’t deserve blame for a future selloff. Consider the so-called FAAMG group — Facebook, Apple, Amazon, Microsoft, and Google — which make up more than 20% of the total weight of the S&P 500. Institutional investors dominate their holdings, and ultimately dictate the market’s moves, Antonelli notes.
Why timing matters
Even so, retail investors can’t live down a reputation for impeccably bad timing and market declines. During last year’s short-lived bear market, for example, the majority of retail investors were selling stocks, according to Barclays.
If this group has reason to sell once again, that could happen during the summer, which historically is a quieter period in markets — and often sees more volatility.
After a strong rally year-to-date, Horneman won’t be surprised if investors “take some chips off the table” heading into the summer. If the pool of retail traders shrinks, that could put pressure on stock prices, Bell adds.
Finally, there’s a psychological component at play. If chatter shifts from “buy, buy, buy” to “sell, sell, sell,” then you may wish to heed Warren Buffett’s advice: “Be greedy when others are fearful.” While some people must lose money firsthand to appreciate the market’s risks, Antonelli says, the past year has offered a valuable lesson about why it’s important to stay invested.
Resisting the urge to follow the pack could be especially important since it’s difficult to predict how a new generation of investors will react to a selloff for the first time. And as the GameStop saga revealed, even the little fish can make a pretty big splash.
“We haven’t seen anything like that happen before,” Bell says. “Allowing retail investors to pool their resources showed they can move the market considerably.”