Pathfinder portfolio manager Hamesh Sharma does a deep dive into some worrying trends created by easy online investing.

Over the last few months, I’ve had many friends ask me if stocks such as Air New Zealand “are good shares to buy right now?” Many of them have never bought shares before.

This highlights to me just how real the current retail euphoria in stock markets is. It also prompted me to investigate the impact retail investors are having on markets right now.

So, what’s driving this meteoric rise of the retail investor? There are a few factors at play.

Pre COVID-19, share trading by small investors was already percolating. The movement was being stoked by discount broking platforms and the onset of slick investor platforms that facilitate easy online trading.

Fractional share ownership, popularised by innovative platforms like Sharesies, allows retail players to buy shares cheaply.  It makes investing widely accessible.

When COVID-19 hit, it was a perfect storm. Quarantine boredom during lock-down combined with the sharp fall in equities saw a massive surge in retail investor buying.

Punters were ripe for it with a silent refrain that went something like this:

“I can’t go to the casino or get involved in a sports bet with the season on hold, so I’ll have some fun trading the stock market.”

The four major U.S. retail brokers reportedly picked up a million new customers over March and April. Outstripping them all though was Robinhood, the app-based pioneer of zero-fee trading.

Robinhood’s customer base was a mirror for sports betting; risk-taking men aged 25-34 looking for a thrill or easy money. They’ve become a big, opaque, driving force of risk, especially over the short time horizons, accounting for 20% of retail investment flows in the U.S.

The charts below from Citi, show how retail investors have been a major player in US equities.

 

 

This is not just a U.S. centric story.

Closer to home, research from corporate advisory firm Vesparum Capital highlights Australian retail investors were net buyers of $9bn in equities between late February and mid-May, while institutional investors have fled the market to the tune of $11bn.

In China, the local market is surging, and five years after China’s last big-equity boom ended in tears, there are renewed signs of euphoria among the nation’s investing base.

Turnover has soared, margin debt is rising at the fastest pace since 2015 and online trading platforms are struggling to keep up.

 

Is this the next Dot.Com bubble waiting to explode?

With the rise of social media platforms, retail participation has mobilised in an unprecedented manner, courtesy of Reddit and Twitter. It’s reminiscent of the cryptocurrency markets in 2017.

This has seen some ridiculous moves with some small company share prices, where things look completely irrational.

A notable example is car rental business Hertz, which filed for Chapter 11 (a preliminary form of bankruptcy involving corporate restructuring) on 22 May; Billionaire hedge fund founder Carl Icahn sold his 39% stake for $0.72 on 26 May to realise a loss of $1.8bn.

By 8 June, Robinhood punters had driven it back up to $5.53 on enormous volume despite the bankruptcy steps.Reality has slowly been restored and Hertz is currently trading down at $1.58.

As of 14 April, the US shale exploration pioneer, Chesapeake had 216,915 Robinhood shareholders. It filed for Chapter 11 on 28 June.

ETF investors also continue to pile into airline stocks, with the U.S. Global Jets ETF attracting record fund flows. Companies – like airlines – who have had a good brand in the past but whose business has been obliterated by Covid-19 don’t typically make good investments.

Closer to home, we have seen this dynamic play out particularly through Air New Zealand shares. Judging by investment flow data we see little doubt that it is the retail investor propping up the stock price at what we see as a material over-valuation.

So how could this end, and what are the investment Implications?

We are in a bubble in certain areas of the market, particularly true in the low quality end of the investment spectrum.

At Pathfinder we are avoiding such companies and focussing on strong business models.  We are far less concerned about “overvaluation” in glamour stocks like the major technology companies and remain bullish on the sector on a medium-term view.

There are open questions as to whether this surge in retail activity will subside as lockdowns world-wide ease further, or if this is a longer-term change in the dynamics of the market. But one thing for sure is that the bubbly areas of the market by their very nature are reliant on ever more money coming in to keep them going.

For a true correction of the bubble, there needs to be a catalyst. It could be from geopolitical uncertainty, a trade war, higher interest rates or a sharp drop in economic growth.

While we would not bet against retail trends, we are certainly not following them. We continue to invest in stocks where we see a solid medium-term investment outlook and themes.

And while we’re all for the rise in the popularity of stock market investing, for many retail investors we believe it is important people do their homework and/or rely on experts when managing their hard-earned investment funds.

At the very least, they should understand risk, as much as the possibility of the returns they’re chasing.

Hamesh Sharma is a portfolio manager with Pathfinder Asset Management. This column is not financial advice or a recommendation to buy or sell any share or financial product.

 

 

 

 

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