The stock market’s sudden rally from the lows in March after lockdown was announced has left many professional investors scratching their heads. Their response has been to dismiss this“recovery” as a blind rally powered by “dumb money”, the irrational exuberance of ignorant retail traders, who, bereft of avenues to spend or invest, are gambling away their extra cash through zero-cost brokers. And this is not just a trend in India.
The US, UK, South Africa,Malaysia, Pakistan and even Iran have seen their stock markets rally.The term, irrational exuberance, coined by Alan Greenspan in 1996 and popularised by Nobel winning economist Robert Shiller, is used to explain a situation where economic agents develop misplaced confidence in the economy and financial markets. It is one of the hypotheses being used to explain the apparent disconnect between the stock market rally and India’s nosediving GDP. In this piece, we try to find evidence to support this hypothesis
So, why are the amateurs getting blamed for their irrational exuberance?
●Emergence of zero commissions or discount brokers: Even with the markets in turmoil, Zerodha, a discount broker, has seen a surge in new users over the last few months -many of them by the millenials in Tier 2 and Tier 3 cities. The number of users logged in simultaneously has doubled to one million users during this period. The number of new broking accounts for it has grown 300% compared to pre-COVID levels and the daily trades on its platform have doubled from 3.5 million to 7 million in April. IIFL, AngelBroking and Motilal Oswal have also reported increase in client addition and average delivery volume per day.
●Social distancing rules keeping people home and lack of avenues for entertainment has led to increase in interest in retail trading as a way to earn some quick bucks, similar to the behaviour of idle gamblers looking for new bets with the stock market being the only “casino” that remained open. People have invested in “lottery stocks” - popular stocks with weak fundamentals with price movements driven by news. Couple this with an overload of news calling this pandemic a once in a lifetime buying opportunity, simplistic thought process of choosing stocks that have historically done well always going up, and FOMO replaces the fear of losing money, leading to a change in the mood of the market, and this degree of retail interest starts making sense.
●Crowd psychology and the power of narratives: With deep mistrust in the news media, and experts questioning numbers being issued by the government, people had no objective way of interpreting the economic news emerging in this black swan scenario, This may have led to stock-market movements being driven by investors’ assessments of other trusted investors’ evolving reaction to the news, rather than the news itself, thus creating a self fulfilling frenzy. Narratives have also played its part in this process .With vivid stories of hardship and business disruption caused by the lockdown, overwhelmed hospitals in the developed world and comparisons to the1930s Great Depression dominating the news, the Indian stock market tanked in March.However, there has been a spike in investor optimism since then after the narrative changed to hope of economic reforms, strong monetary support from the central bankand efficient handling of the crisis by the government.
●Volatile markets and lack of alternate investment opportunities: The ten year rolling returns for Nifty50 declined from 19% in the year ending July 2013 to a record low of 8% in the year ending July 2020, which is less than even the returns on bank and post office fixed deposits (FDs) an investor would have earned over the same period. With interest rates on fixed deposits and other fixed-income instruments sliding and expected to stay low in the near future, investors are buying stocks because they have nowhere else to go. Hence retail investors have turned to this volatile equity market to make better returns. This has been further compounded by recency bias with short term investors having made a killing.. In all, the annualized returns for an investor who entered the market in March this year is more than 100% given that Sensex has recovered 42% from the March 23 lows.
The numbers do support this hypothesis of increased retail participation. The retail ownership of Nifty reached a decadal high in the June FY 20-21 quarter, driven by an influx of new demat account opening by small investors, their share rising to 8.4%, compared to 6.9% five years ago. Retail investor turnover in the first quarter of the current fiscal has shot up 78% from the year-ago period to ₹33,731 crore in the cash segment - increasing to about 57% of the average cash volumes on the exchanges in the first quarter FY21, according to brokerage firm Motilal Oswal Financial Services. So what does this imply?
Say Hi to 'Trash rallies'
A number of companies have been distressed by the ongoing pandemic and initial tanking of their stock prices have contributed to an increase in availability of "cheap" stocks of highly leveraged companies with bad balance sheet risk and low share price. This may have led to a jump in retail investment in these companies with the hope of getting outrageous returns in a very short period. A custom Bloomberg index of the 30 most leveraged stocks out of India’s top 200 companies has gained 32% since the end of March, compared with a 28% advance in the benchmark S&P BSE Sensex. Vodafone India, whose solvency has been in question due to AGR dues and has reported a loss of Rs 73,131 crores in FY 19-20, tripled its value and was the top traded stock in NSE between April and June 2020. Even stocks with "zero equity value" such as GTL Infrastructure Ltd., Suzlon Energy Ltd., and Jaiprakash Associates Ltd. have more than doubled since April this year, against all established norms. In the US, Robinhood traders have generated headlines after users bought stocks of distressed or bankrupt companies, including Hertz Global Holdings Inc., Whiting Petroleum Corp., JCPenny and Chesapeake Energy.
Who cares about archaic terms like valuation and fundamental business analysis when there’s agood enough story?
However, is this the source of the market rally?
Retail investors are not the only ones buying in this market. With a deluge of liquidity due to mammoth stimulus packages across the world, foreign institutional investors (FIIs) inflow into domestic equity markets turned positive year-to-date after they bought Indian shares worth$6.35 billion in August - the highest purchase of Indian shares by FIIs since September 2010when there was a net inflow of $6.37 billion. FIIs account for approx. 21% of the entire Nifty listed universe. Systematic investment plans (SIPs) may also be contributing to this rally. Total investments through SIPs - paid mostly through auto-debits from bank accounts - have remained strong at ₹7,831 crore in July, with SIP accounts rising from 31.4 million in March to32.7 million in July.
So, is the ignorant retail investor really at fault here?
Not entirely. Even Barclays disagrees with the retail investor driven rally hypothesis. Their analysis of the US market found no correlation between retail enthusiasm and stock market performance, either at the index level or for individual stocks. Ironically, their data showed a negative correlation between changes in the number of Robinhood customers holding a particular stock and that stock's returns.So let us give the retail investors a break and let them enjoy their rare moment in the sun, when dumb money might be making better returns than many “rational”agents. And we might want to keep in mind Paul Krugman’s three rules when considering the economic implications of stock prices: “First, the stock market is not the economy. Second, the stock market is not the economy. Third, the stock market is not the economy.”
About the Author: The post is written by our EZPP Partner Abhirup Roy with relevant edits from our editorial team. Abhirup is a graduate from IIM Ahmedabad and works with Zolo Stays.