The U.S. bull market in stocks just celebrated its first birthday this week. Now the question is whether individual investors will remain the life of the party.
The numbers tell the tale. Long-dormant interest in active trading among individual investors had started to revive as a result of the race to zero commissions by major online brokerages. But it was the COVID-19 pandemic, and the resulting market collapse last February and March, that threw fuel on the fire.
It’s difficult to understate the surge in individual investor flows over the past year, which have been “just mind-blowing,” said Eric Liu, co-founder and head of research at Vanda Research, a firm that provides tactical macro and strategic investment analysis to institutional investors.
Those flows have run at four to five times the previous pace and continue to rise this year, he said in an interview, citing the firm’s flow-tracking data (see chart below).
Analysts have attributed the surge in activity to a number of factors, but many come back to the idea that investors left bored by lockdowns on business activity and a lack of opportunities to spend money, including last spring’s stimulus checks from the government, flocked to online brokerages.
Indeed, April 15 of last year, as stimulus payments arrived, marked the heaviest retail buying interest, Liu noted. Another big boost was seen on Jan. 6 as a round of $600 payments streamed in.
The question is whether individual investors will remain focused on the market as the U.S. economy reopens and the pandemic is eventually put in the rearview mirror.
The recent round of $1,400 stimulus checks that began hitting bank accounts earlier this month aren’t being thrown aggressively into the stock market, Liu noted, with net purchases by individual investors this past Monday coming in at the lowest level Vanda has seen all year.
The likely reason, Liu said, is that individual investor portfolios have had a tough month, underperforming the S&P 500 index by at least 11%. It’s clear from the data that when retail traders perform poorly, they’re reluctant to add to equity exposure, he said.
The latest round of stimulus checks are unlikely to get injected into the market “until we get a more pronounced turnaround in the sorts of tech/ESG names that constitute a large proportion of retail’s holdings,” he said.
The data offers an interesting look at how individual-investor activity evolved over the course of the pandemic.
There was a steady creep higher in trading activity into January and February of last year followed by heavy selling through the end of March as stocks made the fastest plunge from record levels to a bear market, defined as a pullback of 20% or more, on record. The bottom for the S&P 500 SPX, -0.72% came on March 23, 2020, marking what by some definitions was the beginning of the current bull market and, no matter how one slices it, an epic rebound that sees major stock indexes trading not far off all-time highs.
The S&P 500 on Tuesday finished 74.78% up from its bear-market bottom and the largest 12-month gain since 1957. The Dow Jones Industrial Average DJIA, -0.67% rose 74.4% over the same stretch.
After the March lows, it was “off to the races” for individual investors, albeit with peaks and valleys, Liu said. Buying interest was “really hot” in the spring of last year, with investors piling into companies that were reopening after the initial lockdowns in the spring. Interest in those stocks dissipated in the summer as a second wave of COVID infections hit, with investors rotating back into highflying large-capitalization technology stocks, then pulling out beginning in September.
A rush into electric-vehicle and ESG-oriented stocks (an acronym referring to environmental, social and governance criteria) followed in November, Liu said. The chart below breaks down the areas favored by individual investors over the course of the pandemic:
Individual investors now make up a much larger chunk of daily trading volumes. In fact, the share appeared to double from around 10% in 2019 to around 20% in 2020, said Shane Swanson, senior analyst at Greenwich Associates, in an interview.
And then there’s stock options trading. Volume in call options, which give the holder the right but not the obligation to buy the underlying security at a set price by a certain time, is at a record high after more than doubling in 2020, said Jared Woodard, head of the research investment committee at BofA.
In some ways, the surge in options activity is among the most notable developments of the past year.
“The way people have used this kind of leverage…to boost buying power is a more sophisticated tactic than we’ve seen before,” Woodard told MarketWatch.
Indeed, aggressive buying of out-of-the-money calls (meaning options with strike prices well above the then-current stock price) has been a favored tactic by traders organized via platforms like Reddit’s WallStreetBets. The coordinated buying forced market makers, who sold the calls, to buy the underlying stock as a hedge, contributing to a buying frenzy that saw shares of meme stocks like videogame retailer GameStop Corp. GME, +46.23% surge earlier this year.
Sophisticated doesn’t necessarily mean successful, much less sound, however.
The surge in trading activity has attracted scrutiny from lawmakers and regulators. Greg Davies, head of behavioral finance at Oxford Risk, a U.K.-based behavioral-finance consulting firm, contends that a tide of “emotional” investing, in which people act on impulses to buy and sell stocks on the back of movements up and down, poses a risk to investors’ long-term well-being.
The surge in individual investing activity “is an opportunity to bring people into more thoughtful investing activity than otherwise would be the case,” he said, in an interview. The flip side is that most of the activity taking place “is a long way from thoughtful or useful…there are an awful lot of people catching falling knives.”
That doesn’t mean individuals should be discouraged from engaging in active trading. Instead, there are tools that can be incorporated into trading platforms that help individual investors better understand their own behavioral biases and shortcomings, he said.
But another wrinkle in the story comes from some of those meme investors, who proclaim themselves not out for profit but to make a point about what they see as the evils of short selling or other activities.
That’s rung alarms for some economists, who fear that the rise of so-called noise traders could render some parts of the market unworkable.
BofA’s Woodard said he doubted the phenomenon posed a systemic risk to markets, but was still noteworthy.
“I think it does tell you something important about the stake people think they have in the system overall,” he said.
Observers had expected individual investor interest to cool somewhat as the pandemic was eventually tamed.
“I would expect you would see some pullback” in activity, said Greenwich’s Swanson.
Individual investor volume won’t evaporate, he said, noting there were 10 million new brokerage accounts opened in 2020. It’s possible that 10% to 20% of those could be lost or go “somewhat inactive,” which would put pressure on retail brokers to make up for lost revenues.
Vanda’s Liu said any expectations for the rise in individual investing activity to largely evaporate were likely to prove off the mark. It was clear that investor interest was building before the pandemic. And in contrast to the stereotype of individual investors buying high and selling low, they instead proved nimble and opportunistic, moving to snap up stocks in the wake of a February-March selloff that left equities at a huge discount, he said.
“The common notion is that it’s just a bunch of 25-year-olds sitting in their parents’ basements…I don’t think that’s true at all,” Liu said.