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Retail Investors and the Recent Rally

Investors should be aware of irrational exuberance

June 21, 2020

We have just experienced some of the most dramatic market moves in history. The S&P hit a new all-time high on Feb. 19 and then fell into a bear market in an unprecedented manner, down 34% in five weeks and reaching a low on March 23. There were four circuit breakers in 10 days.

Then the market began an impressive and remarkable rally, rising almost 45% between March 23 and June 8 despite the economy entering a recession. In the three-day period between March 24 and March 26, the S&P gained almost 18%.

These are truly fascinating times. There are a lot of factors contributing to the recent rally. The one that concerns me the most is the extraordinary amount of new retail investors, especially the young and inexperienced investors and those with a high risk appetite.

Lets take a look at some data:

  • From January through April, the wildly popular trading app Robinhood added a net 3 million new funded accounts. Robinhood now has more than 10 million users, up from 1 million in 2016 and 6 million in October 2018. More than half of the customers have no prior investing experiences. The median age is 31 years old.
  • About 1.2 million retail clients opened accounts at Fidelity investment between March and May, up 77% from same period last year.
  • TD Ameritrade reported 608,000 new accounts during the first quarter of 2020, up 249% year over year.
  • Overall trading volume of the U.S stock market hit $14.6 trillion in March- double the volume of a year earlier. April volume was up 50% over 2019.
  • Robinhoods trading volume in March was three times the average trading volume of the same period in 2019.
  • In June, TD Ameritrade has averaged 3.5 million trades per day so far, more than four times as many as June 2019.
  • Hertz Global Holdings (HTZ) said it would file for bankruptcy protection in May. Carl Icahn (Trades, Portfolio) sold its entire stake at 72 cents a share, only to see Hertz shares soaring past $5.50 apiece.
  • Chesapeake Energy Corp. (CHK) soared 182%, even though the bonds maturing next year were trading at 4 cents on the dollar.
  • Among the most popular stocks are Carnival (CCL), United Airlines (UAL) and Tesla (TSLA).

According to the Wall Street Journal, a 29-year-old electrician in Seattle made thousands of dollars on Hertz call options after the company said it would file for bankruptcy protection.

A 23-year-old salesman in San Francisco put his entire life savings of more than $50,000 in Hertz shares and sold them a day later for almost a 100% profit. He used the proceeds to buy shares in Tesla.

A 22-year-old in Kentucky used a portion of her stimulus check to trade stocks and turned her initial $275 investment into around $800. She traded United Airlines (UAL) and the ProShares Ultra Bloomberg Crude Oil ETF.

Clarly, this is turning into a large-scale gambling game. Some had beginners' luck and won big time. Some were sucked in by fear of missing out.

One contributing factor is the $3 trillion stimulus program as well as the Feds interventions on behalf of maintaining corporate debt, which has distorted the pricing mechanism of the capital market. Those actions, while well-intended, are having consequences that may lead to inevitable pains for retail investors. They are encouraging retail investors to ignore the risks and make them believe that the Fed will do whatever it can do to prevent companies from going bankrupt and stock prices from falling.

Some have compared the recent retail investors enthusiasm to that of the dot-com bubble. The key parallel between 2000 and today is that retail investors are seeing the stock market as a cant miss opportunity, said an unnamed source.

Whether this parallel holds or not, the data is pretty clear that the recent market rally is filled with some irrational exuberance. It may last a while, but if history is a guide, a happy ending is unlikely.

In his latest memo, Howard Marks (Trades, Portfolio) ended with the following words, which I find myself agreeing with:

A bounce from the depressed levels of late March was warranted at some point, but it came surprisingly early and quickly went incredibly far. The S&P 500 closed last night at 3,113, down only 8% from an all-time high struck in trouble-free times. As such, it seems to me that the potential for further gains from things turning out better than expected or valuations continuing to expand doesnt fully compensate for the risk of decline from events disappointing or multiples contracting.

In other words, the fundamental outlook may be positive on balance, but with listed security prices where they are, the odds arent in investors favor.

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About the author:

A global value investor constantly seeking to acquire worldly wisdom. My investment philosophy has been inspired by Warren Buffett, Charlie Munger, Howard Marks, Chuck Akre, Li Lu, Zhang Lei and Peter Lynch.

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