Taking Stock of Retail Euphoria

February 5, 2021—Recent headlines have fixated on a ballooning mass of retail investors contributing to turbulent swings in select corners of the equity market. Most recently these have been in shares of Gamestop, AMC and others, which saw euphoric, triple-digit gains over a matter of days before eventually crashing down to earth. Given the attention devoted to this topic of late, we find it instructive to review the key developments that have set the stage for the changing composition of equity market participants as we outline our thinking about the role and impact of retail investors going forward. While we do not view retail trading as a systemic threat to the broader market, recent activity suggests that retail investors could be a more prominent feature of the investment landscape, and in addition to a series of structural shifts outlined in Theme 3 of our 2021 Capital Markets Forecast, may contribute to a more volatile trading environment.

Figure 1: Retail brokerage volume as a % of overall U.S. equity market volume

Sources: J.P. Morgan Research, FINRA.

Key factors driving the retail resurgence

The sudden surge in retail trading, or at least the media’s extensive coverage of it, seems to have risen abruptly, although the trend has been gradually building for several years before exploding during the pandemic in 2020. According to Citadel, retail trading moved up to 20%–25% of total equity market trading volume in 2020, compared to around 10% in 2019. Data from FINRA shows that the retail brokerage share of U.S. stock and ETF volume swelled to a record 30% in June 2020 (Figure 1). In our view, the retail narrative is first and foremost, a story of innovative fintech companies, including Robinhood and SoFi, challenging the traditional norms long enforced by legacy online brokers. The resulting transformative shift in the competitive landscape that followed helped remove barriers to investing in the stock market for smaller investors before the unique circumstances of the pandemic effectively pushed a retail trading frenzy into overdrive. We believe that the following four factors have been largely responsible for rising retail participation in equity markets.

• A broad move to zero-commission equity trading across major brokerages, and fractional share purchases made trading more affordable than ever. Robinhood officially launched its app in 2015, introducing commission-free trading of stocks and exchange-traded funds (ETFs). Major brokerage houses, including E-trade, Interactive Brokers, and Charles Schwab, followed suit in October 2019, making zero-commission trading in stocks, options and ETFs the industry norm. Another barrier to entry, the high cost of popular stocks like Amazon (currently over $3,200/share), was next in line. SoFi was among the first to sell fractional shares on its platform in July 2019, before Robinhood, Square, and others followed, enabling investors to secure partial ownership of higher-priced stocks with as little as $1. In a November 2020 survey conducted by the FINRA Investor Education Foundation of new investors, one-third reported purchasing fractional shares and the ability to invest with a small amount was the most frequently reported reason for opening a new account (35% of respondents).

• Expanded offerings of low-cost options trading and margin accounts, enabling access to greater buying power with little upfront cost. Robinhood once again turned industry convention on its head by introducing commission-free options trades in December 2017. The uptick in retail share of trading volume has been particularly pronounced in this area of the market, likely a contributing factor to the broad slashing of commissions across major brokers that followed. U.S. total call option volume hit an all-time high in January 2021 (Figure 2). Data from the Options Clearing Corporation (OCC) shows net bullish options trades (calls minus puts) in smaller amounts (1–10 contracts), commonly associated with retail, rose nearly threefold since December 2019. In January 2021, smaller options trades accounted for roughly half of total volume. A Harris poll of individual investors issued in September confirms this trend, showing that 43% of respondents leveraged options or margin trading since the start of the pandemic.
• Technological advancements make trading platforms easily accessible on mobile devices, helping to lure younger investors. Signing up for a brokerage account may have once felt like a daunting task, but user-friendly mobile apps from Robinhood and peers have made account setup seamless and trading shares as easy as ordering a coffee from Starbucks. Robinhood’s highly efficient platform has helped win over younger investors, which surveys have shown may be underinvested relative to older generations. Fed survey data from 2019 showed that consumers under the age of 35 had the lowest percentage of families with stock holdings. Moreover, the percentage that saved was one of the highest, suggesting that this younger age group may have the capacity to invest more than they have been. Surveys of new investors suggest that a younger crowd of traders have been increasingly jumping onboard. According to the FINRA Investor Education Foundation survey, almost one quarter of new investors surveyed are aged 18—29 and nearly half of new investors indicated that they access their accounts primarily through a mobile app.
• The COVID-19 pandemic—excess savings, more screen time, and the allure of bargain stock prices. Due to unique circumstances of the pandemic, the stars aligned for novice investors hoping to get their feet wet in equity markets. After trading at elevated valuations for an extended period, a historically sharp correction in February and March 2020 provided a rare window to purchase stocks at bargain basement prices. The pace of growth in new brokerage accounts confirms that consumers increasingly jumped into the market with both feet in the first half of 2020. According to Robinhood, three million users joined the platform in the first three months of 2020, while Charles Schwab, E-Trade, and TD Ameritrade recorded combined year-over-year new account growth of 316% and 197%, respectively in 1Q and 2Q 2020. Lending further support to the trading boom, many consumers were well capitalized, after the combination of direct payments to households, expanded unemployment benefits, and a drop-off in spending, helped fuel a record rise in the personal savings rate, which remains near an all-time pre-pandemic high. A client survey conducted this past June by SoFi, which tends to cater to younger generations, showed that of the 83% of respondents who received a stimulus check, 50% said they had put at least a portion of the money into the stock market, while a Harris poll of individual investors from September 2020 showed that since the start of the pandemic nearly one-third claim to have increased trading frequency.

Figure 2: U.S. total call option volume (daily average) and timeline of key developments across retail brokers

Sources: Bloomberg, Macrobond.

The recent bout of retail-driven volatility has also shed light on other emerging topics that may draw further scrutiny from regulators. First is the increasing role of social media, which is changing the way investors communicate. Despite spending more time at home, the use of online applications and message boards has seemingly enhanced the flow of information between the newest generation of investors, enabling them to coalesce around favorite trades. Second, is the magnitude of short positions (bets on a stock moving lower) held by hedge funds, which in the case of GameStop amounted to an astounding 140% of shares available for trading. Such extreme asymmetry left short-sellers betting against GameStop particularly vulnerable to a “short-squeeze” in the event of a sustained upward price move putting markets at risk of a potential cascade of forced selling as hedge funds closed out positions en masse. While it remains to be seen whether any regulatory action will be taken, both topics will expectedly be more closely monitored by regulatory bodies moving forward.

Core narrative

As we highlighted in the Market Fragility segment of our recent Capital Markets Forecast, a series of changes in market structure (regulation, rise of ETFs, quantitative trading strategies) over the past decade have contributed to increasingly frequent high volatility events. The retail story has emerged as another structural shift to be watching but does not impact our view as it relates to portfolios. We remain committed to our expectation that the continued rollout of vaccines will help economic activity start to improve later in the year, which combined with further fiscal spending and accommodative monetary policy should provide a highly favorable backdrop for equities and risk assets more broadly in 2021.

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