Retail investors may keep flowing into stocks, but that doesn't mean they have to keep going up

Published Sat, Mar 13 20218:59 AM EST

Wall Street has recast the little guy as the big swing factor in the market, with professional researchers tracking small traders' moves, anticipating waves of new money chasing stocks and calculating the public's influence on how shares are revalued. Yet despite retail investors' far greater role in the market since the Covid crash of a year ago, it's unclear at this point – with equity values and volumes already so elevated – whether individual investors can be the key driver of the broader market from here. Goldman Sachs strategist David Kostin last week asserted that "households will represent the largest source of demand for U.S. stocks in 2021," an estimated net purchase of $350 billion. This forecast is based on historical patterns from prior times when real interest rates were rising and the public redirected cash from bonds and money-market funds to equities. Is $350 billion a lot, in this context? It represents less than 1% of domestic equity market value. And Bank of America notes that in the past four months, a net $476 billion has rushed into equity funds, so $350 billion over the next nine months would be a slowdown. In the same report, too, Kostin notes that the current equity allocation of households, pensions, foreign investors and mutual funds has only been higher 3% of the time over the past 30 years. And their bond allocation has only been lower 3% of the time since 1990. Data from Bank of America's private wealth management clients show a similar skew. This implies that investors are already pretty fully committed to stocks without throwing much fresh cash at them. 'Stimmy' bump? The new fiscal-relief package has checks starting to enter bank accounts at this very moment. Because the ramp in retail trading coincided with the Cares Act direct payments last spring, Wall Street pros have been alert to the chance that the current stimulus money might also slide into the market. The notion of "stimmy" checks, as some on TikTok call them, will drive another speculative story-stock frenzy is a matter of half-joking, somewhat uneasy chatter among investment professionals. A widely shared survey of individual investors from Deutsche Bank this month found that two-thirds of respondents aged 18-34 said they had used stimulus money to invest in the stock market. The same proportion of novice investors (those with less than a year's experience) said so. Yet when the entire survey sample is asked the sources of the money they've invested, government stimulus was only the sixth most frequent response. And keep in mind, the fiscal disbursements are at the same time being promised to the retail sector as a source of quickened spending. The just-passed American Rescue Act includes $650 billion in aid to households, but only $380 billion is automatic direct payments; the rest is extended unemployment benefits. Lisa Ellis at MoffettNathanson, who covers payment-processing companies, figures about half the aid money will be spent fairly quickly, roughly in line with the portion of direct payments spent last year. That would still leave close to $200 billion to be saved or to pay down debts or to buy short-dated call options on a few volatile stocks. And, for sure, this could put a jolt into certain parts of the market. A recent academic study of Robinhood account holdings and other data sources concluded that without the post-Covid retail-trader influx, the aggregate value of the smallest fifth of U.S. stocks would be 30% lower. Measuring retail activity Still, the baseline level of retail turnover and overall market value has risen so much, it's not clear how much a stimulus-sweetened investing push would move the needle. The so-called Trade Reporting Facility is a proxy for activity running through retail brokerage firms, and early this year reached nearly half of all trading volume, up from about 36% 18 months ago. And the average daily dollar volume in U.S. equities is running at more than $600 billion so far this year, according to Piper Sandler – almost double the daily turnover a year ago. None of this is to deny the dramatic influence of an intense retail energy on the stock market in recent months. It's evident in the towering small-order options flow, the intraday swings in popular stocks, the resolute dip-buying in some of the emerging-technology and trendy-themed subsectors in the recent Nasdaq correction. It's simply that this activity has already been flowing strong, and it isn't clear how much incremental oomph will come from rotations out of bonds or more windfall cash from Washington. Some market hurdles ahead And there are some offsets to be aware of. The yawning outperformance of stocks versus bonds this year has institutional asset allocators set up for a pretty significant rebalancing move out of equities and into fixed income. This chart from JP Morgan shows balanced funds' equity exposure above target levels, with tens of billions to sell into quarter's end. Institutional equity traders also have an eye on the coming week's quarterly options expiration, sometimes a watershed moment for a supply/demand inflection. And by some estimates more than $1.5 trillion in stock gains were realized in 2020, which might trigger selling ahead of the tax deadline. In truth, trying to identify and forecast discrete flows into and out of the market is a thankless and pretty futile exercise. We have had years when stocks went up despite net public outflows from stock funds and vice versa. A huge portion of the money going in and out is not captured by the fund-flow data or the corporate-buyback reports. Much of the reason the market keeps going up is that sellers remain sidelined, confident that demand will be there for stocks down the road should they need to sell. And let's not forget that one of the bulls' trusty arguments against the idea the market was vulnerable in years past was, "The public usually embraces the market before a top is in." The reasons to give the market the benefit of the doubt now include its ability so far to coexist with rising bond yields, the consistent cyclical-sector leadership, the sturdiness of credit conditions, the sharp pullbacks restricted to the frothiest parts of the market and the upward trajectory of corporate-earnings expectations. Maybe all this will also draw eager marginal buyers to bid for shares at record highs and with equity allocations already high. But heavy new demand for stocks need not be central to the bullish thesis – nor is it an airtight defense against the bearish case.

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Yet despite retail investors' far greater role in the market since the Covid crash of a year ago, it's unclear at this point – with equity values and volumes already so elevated – whether individual investors can be the key driver of the broader market from here.

Goldman Sachs strategist David Kostin last week asserted that "households will represent the largest source of demand for U.S. stocks in 2021," an estimated net purchase of $350 billion. This forecast is based on historical patterns from prior times when real interest rates were rising and the public redirected cash from bonds and money-market funds to equities.

Is $350 billion a lot, in this context? It represents less than 1% of domestic equity market value. And Bank of America notes that in the past four months, a net $476 billion has rushed into equity funds, so $350 billion over the next nine months would be a slowdown.