Record market highs and bitcoin frenzy are waking up retail investors

Key Points
  • Shares of online brokers have outperformed the market since the tax legislation began to look like it was going to come to fruition.
  • Sandler O'Neill estimates that online brokers will see an 18 to 20 percent increase in earnings in 2018 under this tax-friendly scenario.
Return of the retail investor: Online brokerages see surge in activity

After years of muted trading activity, the retail investor appears to be waking up, and bitcoin can claim partial credit.

"Trading activity usually quiets down in December, but that isn't happening because of the interest in bitcoin, the tax cuts and the markets at new highs," Rich Repetto from Sandler O'Neill told me. Repetto is the lead Wall Street analyst covering online brokerages, exchanges and the trading industry.

Shares of online brokers have been rallying, especially since the tax cuts got real at the end of November, when the Senate Budget Committee advanced the legislation. Since then, the group has outperformed the market, with Charles Schwab alone up 13 percent.

Online brokers outperform (since 11/27)

S&P 500: up 3.2 percent

Charles Schwab: up 13 percent

ETrade: up 9.8 percent

Interactive Brokers: up 7.5 percent

TD Ameritrade: up 4.7 percent

And with good reason: Sandler O'Neill estimates that online brokers will see an 18 to 20 percent increase in earnings in 2018 under this tax-friendly scenario.

But there are other reasons for the rally besides tax cuts.

A pedestrian walks past a Charles Schwab office in New York, U.S., on April 12, 2013.
Scott Eells | Bloomberg | Getty Images

First, there's more trading activity. All the brokers are reporting that daily avenue revenue trades, a measure of trading activity, have been up in November over October:

More trading activity (DARTs in November)

ETrade: up 15 percent

Ameritrade: up 12 percent

Interactive Brokers: up 14 percent

Schwab: up 8 percent

Source: Sandler O'Neill

"With the market up 20 percent, the retail market doesn't want to miss out," Repetto told me.

Second, investors are putting more money in their accounts. Schwab, for example, has record levels of net new assets. And client engagement in the market is up. "The percentage of cash has gone down to two- or three-year lows, because they're buying stocks and mutual funds" rather than keeping it in cash, Repetto told me.

Third, for the cash that is being held in customer accounts, the online brokers are making more money because interest rates are rising, and they are being stingy in paying for that cash.

Finally, it's fair to give bitcoin some credit. Bitcoin futures have slowly rolled out, but the ecosystem around bitcoin, particularly any stocks associated with bitcoin, have seen very heavy activity.

Put it all together, it means profits are higher: Repetto recently increased his 2018 and 2019 earnings estimates for ETrade, Schwab and TD Ameritrade.