Over the last year there have been significant government cash handouts available, designed to help people & businesses through the COVID crisis. In the US, this has seen citizens receive multiple stimulus cheques directly into their bank accounts, most recently in March with payments of up to $1,400 per person. Along with other measures, the payments have helped support a robust economic recovery in the US and elsewhere, but they have also led to several of notable side-effects.
Overall household disposable income has increased and consumer spending has picked-up. (1) Furthermore, aided by the general health of the US consumer, we have also seen significant anecdotal evidence pointing to the increasing prominence of the retail investor - non-professional investors buying and selling securities or funds.
The narrative runs that that relatively well-off consumers, including furloughed citizens, have been unable to spend their wealth on things such as travel and experiences, and instead have invested these funds into stock markets via zero commission app-enabled platforms.
How does it affect the market?
Retail investors are investing their own personal wealth and will tend to trade in relatively small amounts. Nevertheless, they can have an impact on the market. Where there are small stocks with limited liquidity, they may be instrumental in moving the price. Certainly, there have been concentrated flashpoints such as in January when Reddit users took on the hedge fund community and sparked a monumental increase in the GameStop (GME) share price. In the 12 days from 11th January, it spiked 1,645%! (2)
This was extreme, but there have been countless other examples of “meme stock mania”, including AMC Entertainment Holdings, where groups on social media platforms have helped drive up the shares of often speculative companies. It is symbolic of a new era of greater retail influence over stock markets.
Aside from the obvious examples, there is other data to suggest retail investors have become a more important driver of the wider market. Bloomberg Intelligence data shows that during January 2021 daily equity share volumes exceeded the previous peak set amid the global financial crisis in 2008. Looking below the headline numbers we can also see there was a marked increase in retail investing which accounted for 23% of market flow, up from 10% in 2010. (3)
Another result of increased retail investor flows has been the increasing proportion of shares traded ‘off-exchange’ or ‘OTC’ (Over the Counter). This means that rather than being traded on the main exchanges, shares are traded via wholesalers and market makers. OTC trades now account for 47% of all market volume, versus 10% in 2004. Furthermore, in January 2021, $1-$5 stocks what are often dubbed ‘penny stocks’ accounted for 33.9% of OTC share trade volume, up from 15.3% in November 2020. (4)
The question now is whether the rise in retail investing is a temporary phenomenon brought about by the specific circumstances of the last year, or a more permanent shift? Although transitory factors such as government stimulus cheques have helped drive retail investing over the last year, I would suggest the prominence of the retail investor is likely to remain. Crucially, recent technological developments and the aggressive roll-out of app-enabled trading platforms have opened-up investing to a broader retail market.
This ‘democratisation’ of stock markets is to be welcomed and opens up investing to parts of society that have previously not had meaningful exposure to the long-term growth provided by stock markets. However, there are still significant factors of concern.
One of the key misgivings around retail investing surrounds suitability: are the underlying risks of the investments appropriate for an investor’s circumstances & objectives? A large proportion of the recent pick-up in retail trading activity can be attributed to increasing flows into penny stocks. This means that in comparison to the equity market as a whole, retail investors are disproportionately exposed to smaller and usually higher risk companies.
Social media can encourage investors to chase the next GameStop in the hope of making significant short-term gains. Sadly, these opportunities are few and far between, and as we have seen with GameStop a share price can fall-back just as quickly as it has risen. In the meantime, investors may be missing out on the long-term wealth creation potential from a well-balanced portfolio.
A second concern surrounds OTC investing and the hidden risks & costs this entails. These off-exchange trades have no regulatory safeguards and there is often a lack of reliable information about the companies. Furthermore, the bid-ask trading spreads can be wide and trading volumes very thin.
Rather than growing their overall wealth over the longer-term, investors trade in and out of the market, buffeted by volatility, and do not take advantage of the compounding benefits of investing in a broad range of shares over the longer-term. The superpower of stock markets is their ability to compound above-inflation growth over the long-term. This is where investors need to focus their attention.
At Smith & Williamson, when we invest capital for our clients, our first objective is wealth preservation, and beyond that, generating consistent long-term inflation-beating returns. We spend a lot of time making sure we have a deep understanding of our client’s circumstances, aims & objectives and time horizons. This allows us to construct diversified portfolios exposed to appropriate levels of risk. We study markets day in, day out. Trading the markets may be fun, but long-term reliable growth in your wealth is more difficult to achieve.
- Q4 2020 US real consumer purchasing power indicator +4.7% year-on-year.
- Refinitiv Eikon, Price Feed, 2021
- Bloomberg Intelligence Estimates, 2021
- Bloomberg Intelligence Estimates, 2021
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