On July 13 we explained how Silicon Valley engineered a retail trading mania.
As it turns out, the mania has gone global.
“India’s retail investors are leaving their mark on a risky corner of the nation’s $1.9 trillion share market: penny stocks,” Bloomberg reports. “A custom index of 800 stocks that quote below 5 rupees (7 U.S. cents) has trounced the S&P BSE Sensex index by 36 percentage points this year.”
In June, Bloomberg goes on to add, the penny-stock index climbed roughly 10 times faster than the Sensex (India’s version of the Dow).
“Investors are ignoring the rising virus cases, high valuations, and banking on hopes of things going back to normalcy in the next few quarters,” the head of fundamental research at Kotak Securities told Bloomberg. “In this scenario, investing in penny stocks is the most dangerous thing to do.”
More than 2.6 million retail accounts have been opened in India since March, according to data from a depository services firm in Mumbai, with a record 830,045 accounts in June alone.
Among the high-flyers are more than 150 stocks with zero revenues to speak of, let alone profits.
This burst of retail enthusiasm comes as India sees skyrocketing numbers of COVID-19 fatalities and faces its first real economic contraction in four decades as a result of the pandemic.
Given the recognizable trading pattern, it is no surprise Robinhood-style OTPs (online trading platforms) are available in India.
The “bored in lockdown” phenomenon played a role there, too.
“I was never keen on investing in equity as I had an apprehension that it’s akin to gambling,” said Prerna Bhambri, an Indian tennis champion, in an interview with Moneycontrol, an India-based finance site. “During the lockdown, since tennis was off the table for some time, I tried my hand at different things and stock markets caught my fancy.”
New-to-market millennial traders in India, and elsewhere, are also showing an appetite for American household names, like Tesla and the well-known FANG stocks (Facebook, Amazon, Netflix, Google/Alphabet, and Apple).
Then, too, in terms of stimulus, we have an increasingly clear picture of how all this works.
In the United States and other countries, emergency stimulus payments drive spending at the lower rungs of the economic ladder. The more economically endangered a household is, the greater their likelihood of spending nearly all the stimulus that comes in.
But for households more toward the middle-income distribution — qualifying for stimulus, but not in dire straits — there is a greater propensity to save a larger portion of the incoming stimulus, or perhaps invest it in the stock market.
If the stimulus recipient is a millennial without immediate family responsibilities, the impulse to invest — or take a punt on penny stocks — will be even stronger.
Today’s global army of newly minted retail investors may not have a lot of firepower compared to, say, the giant pool of capital run by professional managers and institutional funds. But a handful of structural factors explain why retail traders worldwide, not just in the U.S., are punching far above their weight class in terms of net impact on stock market prices.
First, these retail traders often count as the “marginal buyer,” meaning they are the ones pushing stock prices higher at the margins.
If a thousand buyers are willing to purchase a stock at $4.95 per share, and only one is willing to bid $5.00, it will be the lone bid at $5.00 that generates the print. If the whole group moves to $5.00 and a lone bidder goes to $5.05, the same thing happens again. In this manner, enthusiastic buyers can continuously push prices up.
Second, retail traders appear to be extremely active, which increases the size of their footprint. A small brokerage account that does 10 transactions per week can have a far greater impact on markets than a large brokerage account that does 10 transactions per year.
Third, this global wave of Robinhooders has a taste for short-dated call options, a means of getting more near-term bang for the buck. A short-dated call option is like a firecracker — it either explodes in value or proves to be a “dud” very quickly.
When retail traders as a group buy large quantities of short-dated call options en masse, on a rolling continuous basis, the market makers who sell the options are forced to constantly buy underlying shares in the open market, in order to hedge their risk.
And fourth, for equity names that have global branding — like Tesla, for example — the bidding power is increased by the phenomenon of retail flows trickling in from all over the world.
All of this is worrisome not because of the party-like atmosphere, or the insane valuations, or even the slew of names that have no real business trading at all (like the bankrupt HTZ and others), but because of what happens when the party finally ends.
Take the above-noted basket of 800 penny stocks trading below 5 rupees, for example. When speculative fever withdraws — as always happens, eventually — hundreds of names in the basket, if not the vast majority, are likely to collapse, because the bullish sentiment pushing them higher was not based on anything sustainable.
If this sudden withdrawal of retail interest happens too quickly, the result can feel like a deflationary bust. When retail psychology turns south, these enthusiastic amateurs may not only stop investing, they might stop spending in the local economy, too. While an inflating asset bubble is a cause for bullish celebration, the deflationary impact of a burst bubble’s aftermath can be a steep price to pay.
Then, too, the central bank might decide that letting an asset bubble pop is just too risky, due to the deflationary consequences as just explained.
If the “can’t let it pop” call is made, the central bank, in tandem with the government, might take new measures to shore up sentiment and keep the bubble intact. But in the long run, all this winds up doing is inflating the bubble further, threatening even uglier consequences when it pops.