Retail investors awakened by Covid-19 slump

THEIR absence is lamented. Yet, their presence elicits bewilderment, worry and even ridicule from market commentators.

They are referred to as retail investors, or mom-and-pop investors. But the context in which these terms are used often leaves no doubt as to the underlying pejorative meaning.

These investors are regarded by the financial industry as fickle and uninformed. They take too much risk for too little potential return. They sell winning stocks too fast, and hold losers too long. They create pricing anomalies that the market would be better off without.

In short, they are the dumb money.

Yet, retail investors now appear to be confounding professional money managers. According to data from the Singapore Exchange, retail investors have been big net buyers of local blue chip stocks since the market hit its March lows in the face of the Covid-19 pandemic. Institutional investors have been big net sellers.

In effect, the institutions were offloading their holdings to retail investors as the market climbed from its lows. And, that trend continued all the way into June.

From the week of March 2 to the week of June 22, retail investors were net buyers of local stocks to the tune of S$5.46 billion, according to the SGX data. Institutional investors were net sellers of S$5.13 billion worth of local stocks.

To put that in perspective, for the whole of 2019, retail investors and institutional investors were net sellers of about S$908.7 million and S$1.42 billion worth of local stocks, respectively.

So far, retail investors appear to be on the right side of the trade. The Straits Times Index is up nearly 19 per cent from its March low, and some analysts are saying that there could be more upside as global economic activity continues picking up.

Why have retail investors returned to the market in such a big way after years of waning interest? Is this something to be celebrated? Or, should it be a cause for concern?

Global phenomenon

The pick-up in retail investor activity in recent months is not unique to Singapore. From the US to Japan, brokerage firms across the world have reported a surge in new account openings and an explosion of trading activity by their retail investor customers.

Some have attributed this to small investors being enticed by the massive fall in stock prices triggered by the Covid-19 pandemic.

It has also been suggested that being stuck at home has prompted many people who never got around to building a stock portfolio to take the plunge. Indeed, some investors have reportedly kicked off their trading activities using funds obtained from government stimulus programmes.

Then, there is the popularity of Robinhood, the slick trading app that has drawn millions of novice millennial investors in the US. The commission-free platform that offers options, margin trading and even "fractional" shares has reportedly opened more new accounts this year than Schwab, ETrade and Interactive Brokers combined.

Whatever the case, some market watchers have begun to worry that the big surge in relatively inexperienced investors participating in the market isn't healthy. In one tragic instance, a 20-year-old customer of Robinhood took his life after looking at his options position and mistakenly coming to the conclusion that he had lost more than US$700,000.

In another case, shares in troubled car rental firm Hertz rocketed in late May and early June, after it filed for bankruptcy. The run was said to have been fuelled by retail investors not seeming to care that they were chasing potentially worthless shares.

In a perfectly rational reaction to its soaring stock price, Hertz said it would raise US$500 million through the issue of new shares, which would probably have ended up in the hands of its creditors. Hertz pulled the deal after it drew scrutiny from the US Securities and Exchange Commission .

Academic viewpoints

Are retail investors just "noise traders" disrupting the process of price discovery? Or, are they collectively contributing to more accurate market prices? How could their impact on the workings of the market even be measured?

Attempting to find the answers to these questions led me down a rabbit hole of academic literature that seemed to prove everything and nothing. But here are some of things I learnt:

There is certainly a school of thought that comes down on the side of retail investors, on the basis of there being a statistically significant correlation in some markets between high levels of retail investor trading activity and high firm-specific stock return variation.

The big assumption here is that high firm-specific stock return variation - or, to put it simply, a low correlation between the market price of a stock and the market price of other stocks within the same industry group or market - means that the market price of the stock is more "accurate", in the sense that it largely reflects its own micro fundamentals.

Many people with practical experience in the markets would probably disagree with that premise, and offer as proof the numerous stocks they follow that are uncorrelated with the broad market but have valuations that couldn't possibly reflect their micro fundamentals.

There is doubt in academic circles too. One study found that stocks with low correlation to their industry group and market tend to have poor earnings and weak fundamentals. So, the low correlation might not reflect share price accuracy but high levels of uncertainty faced by investors.

Even more compelling is the theoretical argument that if a company were completely transparent, its share price would reflect all the information related to its micro fundamentals, in which case its share price would only change in response to some industry-wide or market-wide development. In other words, the company's supposedly "accurate" share price should display high - not low - correlation to its industry group and the market.

Some will lose money

My own instinct is that we should not underestimate the usefulness of broader retail investor participation in the market at this particular moment.

Not all retail investors are uninformed and inexperienced, even if as a group they are less savvy than professional investors. Moreover, many veteran analysts and fund managers are themselves unsure how the impact of the Covid-19 pandemic on the market will play out. And, they are getting little guidance from the corporates, because the corporates don't really have a clue either.

Against this backdrop, the presence of a wider variety of investors, with sharply different perceptions and tolerance for risk, is likely to be beneficial for the market as a whole. Certainly, it was useful for institutional investors beating a retreat from the Singapore market over the last few months.

Of course, some retail investors will probably end up losing money, especially if they are inclined to keep chasing shares of bankrupt companies. Market regulators ought to look out for signs of excessive speculation, and monitor the use of margin financing.

For many other retail investors, however, jumping into blue chip stocks as they dived in the face of the Covid-19 slump might turn out to be one of the smartest moves they have ever made.