Are Retail Investors Driving Volatility?

Dear Rich Lifer,

Retail investors who have flooded their cash into meme stocks and cryptos continue to pour money into the stock market.

When the Covid-19 pandemic swept through the U.S, many first-time traders entered the market, propelled by extra savings, more time at home, free trading apps and the emerging popularity of “meme stocks.” 

With these trendy stocks and cryptocurrencies facing steep declines, many experts expected that retail investors would begin to retreat from the markets. 

But it looks like these “new” investors are here to stay… 

In fact, just last month they bought almost $28 billion of stocks and exchange-traded funds on a net basis, according to data from Vanda Research’s VandaTrack.

This is the largest monthly amount purchased since 2014! 

Today, we explore this not-so-new group of investors and explain the effect they are having on market volatility.

The Rise of the Individual Investor 

Just in the first half of 2021, 10 million new brokerage accounts were opened by individual investors, according to estimates from JMP Securities.

This number is already equal to the total number of similar accounts opened in all of 2020.

As we mentioned above, the Coronavirus pandemic created the perfect climate for increasing individual investors’ shares of U.S. equities trading volume. It rose to 20% last year, about double the number from a decade before, according to data from Larry Tabb, head of market-structure research at Bloomberg Intelligence.

That share has only continued to grow this year, even as some retail investor favorites have faltered.

“Meme Stocks” Stumble 

Some of the retail investor darlings such as Gamestock, AMC and Dogecoin have all seen recent, sharp declines in value. 

Shares of AMC Entertainment Holdings Inc. dropped 12.3% after the company announced it planned to ask shareholders for the authority to issue 25 million new shares, to a total of about 594.2 million shares. A month after this initial announcement, the company reversed its decision, and shares have increased slightly but are still down from early June highs.

Another retail investor favorite, Dogecoin, is also down about 67% from its May record.

The most famous of the meme-stocks, GameStop, has stalled at around $200 after soaring to $483 earlier this year.

But while the stocks that retail investors rode to the top are slipping, it’s clear that individual investors are here to stay. 

Main Street Buyers Make Their Mark 

Mr. Tabb of Bloomberg Intelligence made his predictions for the future of the retail investor, commenting, “They definitely have influence, and they’re not going away. We think for the next year or so, 18% to 22% of the market will be driven by retail.”

And now that meme stocks and cryptos are less popular, retail investors are channeling their funds into other parts of the market. 

Viraj Patel, global macro strategist at Vanda Research, observes, “There isn’t any one particular theme dominating when it comes to retail buying, which is unusual compared to the herd-like behavior we saw from retail investors earlier in the year chasing a specific set of stocks.”

Regardless of what they are buying, trends show that individual investors are still making their mark by employing traditional tactics of “buying the dip.” 

For example, on June 18, all three major U.S. stock indexes pulled back 1% or more. How did retail investors respond?

They bought more than $2 billion of shares on a net basis — beating every single day in the last two years, according to VandaTrack data.

Jason Goepfert is the President of Sundial Capital Research, which tracks how sentiment varies between individual traders and institutional investors. He notes that optimism among individual investors is incredibly high, with 70% confident that U.S. stocks will keep rising over the next three months.

Which leads us to the current disconnect between individual investors and professional traders.

Professionals Fear Volatility 

Optimism among individual investors may be high, but among institutional investors, it’s not. The same research from Sundial Capital revealed that only 44% of professional investors are confident stocks will continue to rally. 

The month of June was remarkably calm for the markets. In fact, the gap between the S&P 500’s daily peak and trough narrowed to 0.62 percentage points — the lowest level of intraday volatility within a month since December 2019, according to Howard Silverblatt, senior index analyst at S&P Dow Jones Indices.

But analysts are bracing themselves for a mood shift. Why?

With the summer comes more traders taking time off, which results in generally less liquidity in the markets. Therefore, any unexpected economic data will “hit the market harder than they otherwise might,” said Nicholas Colas, co-founder of DataTrek Research.

Mr. Colas went on to explain that “ since volatility and returns have a negative correlation, this dynamic can make for difficult investment environments.”

The Cboe Volatility Index (VIX) is often used by traders to determine whether to bet on or hedge against the markets. The VIX tends to rise when stocks fall and fall when stocks rise. Right now, the VIX is up 13.93%.

But while volatility may be a fear for professionals, it seems that it’s the exact opposite for individual investors.

Fueling Volatility? 

Retail investors are not shying away from potential market volatility. In fact, volatility can be an asset for those looking to make big returns as individual investors.

One such person, Alex Salfetnikov, a 24-year old full-time individual investor stated:

Volatility is kind of key for a retail trader… At this point, I don’t necessarily care a whole lot about what the overall market does. To me, as long as there’s volatility in the market — upside or downside — I can make money.

Further, researchers from the University of Western Australia have concluded that retail investor activity has “stimulate[d] abnormal trading activity and volatility in financial markets.” 

So retail investors both benefit from and create volatility. The whole phenomenon seems like a cyclical trend with volatility being continually created and exploited. 

As the summer plays out, keep this in mind and make sure your portfolios are prepared for any unexpected market events.

To a Richer Life,

The Rich Life Roadmap Team 

 

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