The last time retail participation in the market dried up, was back in May when three months after retail investors took the stock market by storm sparking a series of historic short squeezes in meme stonks such as GME and AMC, the money from various stimmies dried up and retail enthusiasm for stocks suddenly faded.
We discussed this on May 9 when we said "Retail Participation In Stock Trading Has Collapsed", and pointed to the plunge in call option volumes, which had emerged as the preferred investment vehicle for millions of GenZ and Millennial investors.
Perhaps coincidentally, our warning that day marked the top for the market for the next few weeks, with the S&P sliding some 200 points in just the next four days.
We bring this up because at a time when retail investors have become instrumental in propping up the market and buying each and every dip, this time around retail enthusiasm is once again fading.
Maybe it is because the S&P is at all time highs, or because retail euphoria has shifted to cryptos which have vastly outperformed even the most perky meme stonks, but as Vanda Research which tracks traffic on retail trading platforms and industry-wide order flows, the scale of retail interventions is getting smaller. This, according to the firms strategists, raises the chances of more serious declines if big investors continue to retreat.
“While we have seen a pick-up in ETF buying this week, the magnitude has been a little underwhelming relative to previous selloffs,” Ben Onatibia and Giacomo Pierantoni wrote. “This diminishing appetite to support the equity rally raises the odds of a larger selloff if institutional investors continue to sell.”
While this is especially bad news for apps like Robinhood whose entire business model depends on continued retail main, it is also bad news for bulls overall, as the army of retail traders has reliably shown up to buy broad ETFs at various points in 2021. And while they did so again in the five days through Tuesday, with $657 million of purchases, as Vanda's Onatibia and Pierantoni note in the chart below, such buying was between 35% and 100% larger during similar-sized drawdowns in July and August.
Here Bloomberg adds that while seasonal factors could be at play - as vacations end and a new school year begins - there’s another worrying sign according to Vanda: Retail investors have been concentrating their buying in tech stocks.
“There are two distinct phases in the outperformance of technology shares,” the strategists wrote. “The first one is usually driven by institutional investors, who enter the trade when valuations are attractive. The second leg of the outperformance happens when FOMO-driven retail investors join the trade." And since we are currently in the FOMO leg, it hints at “an imminent reversal” in market leadership, they said.
Incidentally, the fate of retail dip-buying was cited by JPM quant Nick Panigirtzoglou last week as a potential counterweight to the growing bearish sentiment among major Wall Street banks. As we discussed in "The Six Largest Wall Street Banks Issue Market Red Alerts" in which we noted that the most popular sellside strategists had turned somewhat - or very - bearish, expecting an imminent correction anywhere between 5% and 20%, the JPM quant said that one possible saving grace was that retail investors have been buying stocks and equity funds at such a steady and strong pace "that makes an equity correction looking rather unlikely."
"So far this year retail investors have been buying stocks and equity funds at such a steady and strong pace that makes an equity correction looking rather unlikely" Panigirtzoglou wrote, adding that "whether the coming Fed policy change changes retail investors attitude towards equities remains to be seen."
At the same time, he also conceded the counter argument, namely "that the strength of the retail flow has pushed equities up by so much and has made investors globally more overweight equities, many of them unwilling, that the risk of profit taking should be naturally high. Indeed, in support of this counter argument, updating our most holistic of our equity position indicators, i.e. the implied equity allocation of non-bank investors globally, points to an equity allocation of 46% currently, only slightly below the post Lehman crisis high of 47.6% seen in 2018"
And while the JPM quant admits that he is sympathetic to this counter argument, "in the absence of a material slowing in the retail flow into equities, the risk of an equity correction remains low." As such, we concluded last week, in his view monitoring this retail flow on a daily and weekly basis going forward "is key to the equity market outlook."
Considering that the latest retail trading data shows to an continued decline in the pace of purchases, it is merely the latest risk to consider when buying stocks some 2% away from their all time high.