(Bloomberg) Purpose Investments CIO Greg Taylor has seen his share of bubbles and buying frenzies: dot com, crypto, cannabis. But he says the “bankruptcy bubble” which emerged in the past few weeks is the biggest he’s ever seen.
Stocks such as Hertz, JC Penney and Chesapeake Energy that seemed like duds were in demand.
“It’s a head-scratcher because people are getting involved in volatile penny stocks but the underlying fundamentals of these companies are horrific,” Taylor said. “These are companies that are for all intents and purposes bankrupt; they have too much debt and the stocks are going up 50 to 100 per cent a day. You’re not investing, you’re gambling.”
This frenzied interest in certain high-risk penny stocks has Wall Street veterans at a loss to explain what’s going on, and what to expect.
Many blame so-called “Robinhood investors” — retail investors drawn to the stock market because of the recent post-plunge rally. The term “Robinhood” is a nod to the American app that advertises free stock, options, ETF and cryptocurrency trades.
Robinhood added three million new accounts in the first four months of this year. About half of those new accounts were first-time investors, according to the company. It isn’t available to people in Canada but low-cost trading platforms such as Questrade and the fintech app Wealthsimple also reported a spike in new users.
This renewed interest from Main Street came during the throes of the lockdown, with sports canceled, and stimulus cheques arriving from the government. Flush with stimulus cash and deprived of live entertainment, the stock market emerged as a popular distraction for novice investors.
Even though the number of Robinhood investors has soared, they make up a small percentage of the market and overall trades. Based on recent data, Purpose Investments’ Greg Taylor says retail investor involvement is growing and currently accounts for about 25 per cent of U.S. market volume. But a specific type of trade they’re executing has an outsized impact because of the nature of equity markets.
Taylor says that about 15 years ago, U.S. stock markets shifted from being a vehicle mainly for people making trades to machines — specifically algorithms, which execute a pre-programmed trading strategy for institutional investors. Canadian markets switched over about a decade ago.
Taylor says finding exact numbers is difficult but estimates that on a typical day, computers account for more than half of market trades. On extremely volatile days, he says that number can be as high as 90 per cent of trades.
These algos are programmed to seek out the stock trading landscape for action. So when a number of Robinhood investors, sometimes inspired by a declaration on social media, plough into a penny stock, the most sensitive algos join in. This increased activity in a thinly-traded stock then attracts more algos, sometimes drawing in other retail investors and creating a type of feedback loop. Activity begets activity and what starts out as a small number of investors trading relatively small sums suddenly has an outsized impact.
Based on a third-party aggregate of Robinhood trading data, users of the Silicon Valley app timed the market bottom well according to Andrew Lapthorne, a global quantitative research analyst at Société Générale.
“The reason for all the recent publicity surrounding Robinhood investors is that when it comes to bombed out distressed equity, retail investors have a bigger voice and therefore greater potential influence,” he said in a mid-June note to clients.
This echoes findings by Goldman Sachs which suggests that for all the mocking of newbie investors as “dumb money,” they have, collectively, made some good calls.
In a June 14 note to clients, Goldman’s chief U.S. equity strategist, David Kostin, estimated retail investors in the U.S. outperformed American hedge funds (up 61 and 45 per cent, respectively) during the market comeback.
As a group, these Robinhood investors have done well for themselves, but that doesn’t mean there aren’t perils for individuals, especially young and inexperienced ones, who get in over their head.
In late March, inexperienced investors were cited as a factor in a penny stock called Zoom Technologies Inc. surging more than 240 per cent before the SEC suspended it. The Beijing-based company, which had never reported on its finances since going public in 2015, was mistaken for Zoom Video Communications Inc., which has been a primary beneficiary of the work-from-home trend during the pandemic.
On June 9, a small Chinese real-estate firm called Fangdd Network Group Ltd. saw its market cap jump 13-fold to US$4 billion. Novice investors were blamed for piling into it because its name resembles the FAANG acronym, for Facebook, Amazon, Apple, Netflix and Google parent company Alphabet.
Overall though, Greg Taylor says a wave of interest in equities is healthy so long as individuals do their research, and only use leverage when they fully understand what they’re getting into.
“For the last few years people were more interested in investing in real estate and condos. I think having people back in the equity markets overall is good,” Taylor said. “The problem is when it blurs the line between investing and gambling. With sports cancelled and online gambling leading more towards the stock market that’s where it gets really dangerous.”
