Retail Investors Have Capitulated And Are No Longer Forced Sellers Of Stocks
Is the great retail puke finally over?
Regular readers will recall that about a month ago, JPMorgan found that ahead of the mid-May burst of selling dragged the S&P briefly into a bear market, the retail buying impulse showed signs of slowing and after adjusting for inverse ETFs, not only did the May retail net flow turn negative for the first time since Mar 2020, but also the monthly inflow in April was smallest since Sep-2020.
However, despite that sharp reversal in recent retail optimism, JPMorgan quant and flow expert Nick Panigirtzoglou wrote in mid-May that he was skeptical of the idea that April’s equity fund outflow, the highest outflow since March 2020, was only the beginning of a likely more protracted phase of equity fund outflows in reversal to 2021’s record inflows. And indeed – as he picks up in his latest Flows and Liquidity note (available to professional subscribers in the usual place) helped by strong inflows over the past week, May has seen a small inflow into equity funds, partially reversing the April outflow.
Meanwhile, the YTD inflow into equity funds still stands in decent positive territory as shown in the next chart.
However, when looking at the latest data, JPM’s Panigirtzoglou writes that this does not mean however that there has been no retrenchment by the older cohorts of retail investors, i.e. those that have been investing in the equity market via equity funds.
As discussed before, the magnitude of retrenchment is not only a function of flows but also valuation effects. And the fact that equity funds saw heavy losses YTD in terms of AUM implies a more significant retrenchment that that implied by flows alone. By taking into account both flows and performance, JPM has calculated that equity funds globally, including the equity portion of hybrid funds, lost $5 trillion of AUM YTD, effectively reversing most of last year’s $6 trillion increase.
In other words, the YTD retrenchment of the older cohorts of retail investors looks a lot more significant in fund AUM terms, reducing the need for any further equity fund selling going forward.
What about the younger cohorts of retail investors that tend to use leverage via margin accounts and prefer to invest via individual stocks or options? To assess leverage by retail investors, JPMorgan uses its leverage metric based on monthly data from NYSE margin accounts.
This leverage metric has been sliding fast since last October in its biggest drawdown since Q4 2018 (outside the pandemic). Notably, the end-April level of this leverage metric matches that seen in September 2019 or December 2018. In other words, Panigirtzoglou concludes, “the deleveraging by younger investors has advanced by so much that all the previous post pandemic increase has been unwound already.“
A similar picture emerges from retail investors’ call option flows.
A high frequency (weekly) proxy of this US retail impulse is the one based on small traders’ equity call option flows, i.e. option customers with less than 10 contracts. These data come from OCC, the world’s largest equity derivatives clearing organization. They are weekly, with the week ending May 27th as the last available observation.
The chart below depicts these small traders’ call option flows for exchange-traded individual equity options in the US. Here JPM finds that “call option flow has been downshifting since last year and currently stands at its lowest level since December 2019, again reversing all of the previous post pandemic increase.”
A look at equity baskets containing the stocks most popular among the US retail trading platforms conveys a similar message of well-advanced de-risking by the younger cohorts of US retail investors, having unwound all of the previous post pandemic increase.
Putting it all together, the JPM quant writes that helped by strong inflows over the past week, May saw a small inflow into equity funds, partially reversing the April outflow. More importantly, the YTD retrenchment of older retail investors looks a lot more significant in equity fund AUM terms, having unwound most of last year’s increase, thus reducing the need for any further equity fund selling from here according to JPM, which adds that both its leverage metric based on NYSE margin accounts and small traders’ call option flow “suggest that the deleveraging by the younger cohorts’ of retail investors has advanced by so much that all the previous post pandemic increase has been unwound already.”
In other words, retail – which was puking stocks for much of the past few months – has now (almost) completely deleveraged and won’t be a forced seller from this point onward.
Which is not to say that everyone agrees retail has given an “all clear” to more equity upside: citing data from Vanda Research, Bloomberg notes that emboldened retail investors rushed to the rescue as stocks fell this week, supporting an intra-day rebound in the S&P 500, but failed to hold into the close in the last two sessions.
According to Vanda, “despite the strength shown this year, we do remain wary that retail purchases could begin to ebb and re-ignite capitulation fears if this proved to be yet another bear-rally”, which one can say about any other investors class too, of course.
This, to Bloomberg suggests that signs are emerging that day traders are starting to doubt the recovery in equities and are looking to hedge: “Retail investors have been awarded a big win with market’s late May rally, with a Goldman Sachs basket of stocks most popular on retail brokerages halting a seven-week streak of losses to post its largest gain since mid-March last week. “
And while retail clearly continued to chase stocks as they dipped Tuesday, this category of traders also bought a near-record amount of bond ETFs, according to data from Vanda Research.
If equities fail to bounce further, analysts noted that retail may be looking to buy more bonds as a hedge, potentially taking some support away from the stock market.
There are other bearish signals coming from the options market, where participation remains persistently high (day investors are behind nearly a third of all options volume since early 2020, per Bloomberg Intelligence). According to Vanda, the premium traded in at-the-money and in-the-money calls has dropped considerably…
… while trading in out-the-money puts is nearing 2020 highs, suggesting that investors are increasingly hedging for more downside while capitulating on hopes for sharp upward gains.
The full JPM and Vanda notes are available to ZH pro subscribers.
Thu, 06/02/2022 – 14:46