How a rush of a high-energy, momentum-embracing retail traders is remaking markets

Published Sat, Feb 20 20218:02 AM EST

The rush of retail investors into stocks is putting a charge into the post-Covid bull run while also turning trusted market signals staticky and upending some familiar trading patterns. About 10 million or so new online brokerage accounts were opened last year by relative newcomers who are, in general, shunning the plodding, passive, get-rich-slowly approach in favor of playing small, fast-moving stocks, short-dated options and unproven companies with a claim on some big-picture societal trend. This action is changing the market's metabolic readings in several ways, the clearest perhaps being the blistering turnover rates in the riskier regions of the tape. For years, overall trading volume has ebbed in rallies and surged on sell-offs. Fear is a more intense emotion than greed, in general, and spikes in volatility tends to drive more involuntary portfolio changes than do gentle uptrends. Not anymore. As the market has steadily climbed to repeated record highs since late October, total equity volume has swelled by some 50%. And yet the turnover in the most widely held broad-index ETFs is down over that same period. Numbers pulled together by technical strategist Frank Cappelleri at Instinet show daily volume in the flagship SPDR S & P 500 Trust and Invesco QQQ Trust are off by some 40% over the same period. The bulk of the new volume is away from the big indexes, largely in smaller, more speculative tickers. This chart from Leuthold Group shows the ratio of daily volume in Russell Micro-Cap stocks has surged to one-third large-cap Russell 1000 stocks' level, from half that level a few months ago. To say the least, this hyperactive flow is being initiated from the bid side: The iShares Micro-Cap ETF (IWC) is up 27% for 2021, seven weeks into the year. Even among large-cap stocks, those with lower nominal share prices are getting the most attention. Bespoke Investment Group calculates that the 50 S & P 500 stocks with the lowest share prices at the start of 2021 are up an average of 16.2% year to date, while the highest-share-price 50 are ahead by just 3.9%, lagging the S & P 500 itself by a bit. Even in an era of fractional share-buying capabilities and zero commissions, the psychology of "buying low" and playing for fast moves now favors sub-$50 names. 'Driving force' of the market This is an exact reversal of the pattern that held for most of the 2010s bull market, when FAANG leaders Amazon and Alphabet and growth-stock darlings Chipotle and AutoZone let their shares run unsplit deep into the four figures, and high-share-price was persistently an outperforming investment factor. The big banks' investment-strategy teams have all been busy producing careful studies of the new retail-trading phenomenon, seeking to teach institutional clients about the customs and habits of this novel species, the way high schools run workshops for parents to help them understand their teenagers. In one such report last week, JP Morgan quantitative strategist Nikolaos Panigirtzoglou explained that "monitoring the overall flow impulse by U.S. retail investors is important going forward, as this flow impulse appears to have been the driving force of the risk market rally since November." He notes that retail traders tend to favor a mix of big tech stocks and a broader array of small-caps, making a blend of the Nasdaq Composite and the small-cap Russell 2000 a decent proxy for their preferred portfolio. In theory such a mix should behave roughly like the S & P 500. Yet the lines diverged late last year and the gap continues to widen. Nowhere is the new retail energy more apparent than in the overwhelming quantity of call options bought every day. The volume of small bullish options trades made at the open, a proxy for retail flow, is up by a factor of eight since the start of 2020. The ratio of calls to puts, largely stable for 20 years, has soared into a new range, a level of persistent bullishness last sustained in the late-'90s. Another trusty signal fouled by all this excited retail buying: The Volatility Index. The VIX has not descended below 20 for more than a few moments since the onset of the Covid crash just about a year ago. It is unusually elevated relative to the steady strength in the equity indexes, clocking new highs for months now. While presumably this represents in part abiding demand for downside protection from institutions (VIX is driven by prices for put options), derivatives experts say the intense buying of single-stock options itself is inflating VIX as dealers widen out the range of anticipated market moves and hedge their exposures. This means the VIX above 20 might not represent quite as high a constructive "wall of worry" as it otherwise might have in the past. And, not least, the intentional collective short squeeze in GameStop and a few other "meme stocks" late last month – initiated if not fully executed by small traders – has led to a mass covering of short positions across the market, now near a record low as a percentage of market value. A minimal short cushion merely adds to the overall extremes in long risk positioning across the market. What it all means for the broad market setup is the obvious question, and not an easy one. Sure, there are speculative excesses in clusters of the market and nodes of overconfidence. And even aside from those, it's pretty easy to see a window for a break in this rally some time this quarter. Elevated sentiment, something approaching "all-in" equity positioning, seasonal headwinds, a coming asset-allocation rebalancing shift out of equities, the cycle work on prior mega-rallies to start bull markets (1982 and 2009) all allow for some slippage. Mini-manias and micro-crashes And yet the retail chase and the wild price action it creates have not made their way into the core of the market reflected in the S & P 500, which has been in a well-behaved uptrend punctuated by pauses rather than pullbacks, supported by firm credit conditions and a homeostatic rotation. Berkshire Hathaway broke out last week to a new high, after all, which is neither bearish for the market nor a mark of small-trader speculation. If investors' overall risk posture keeps growing more acute and if perhaps the bond sell-off turns less orderly, the erratic flows in tiny and trendy stocks could certainly be a stress trigger for the broader tape. Yet the GameStop drama and the surge-and-collapse recently in cannabis stocks show that mini-manias and micro-crashes can occur without, so far, derailing the major indexes' work of adapting to higher bond yields, weighing another fiscal infusion and recalibrating sector valuations for an economic acceleration. And the growing prominence of a high-energy, momentum-embracing, disruption-delighted new investing crowd probably implies the market will be less rigidly mean-reverting and perhaps open to more "extreme extremes" before any serious reckoning interrupts the fun.

Traders on the floor of the New York Stock Exchange

Source: The New York Stock Exchange

The rush of retail investors into stocks is putting a charge into the post-Covid bull run while also turning trusted market signals staticky and upending some familiar trading patterns.

About 10 million or so new online brokerage accounts were opened last year by relative newcomers who are, in general, shunning the plodding, passive, get-rich-slowly approach in favor of playing small, fast-moving stocks, short-dated options and unproven companies with a claim on some big-picture societal trend.

This action is changing the market's metabolic readings in several ways, the clearest perhaps being the blistering turnover rates in the riskier regions of the tape.