December Newsletter – The Rise of the Retail Investor

One of the aspects that we have seen both in the United States as well as in many other countries including India has been the rise and rise of the Retail Investor. For long seen as the weak hands, today they seem like a fearsome clan of hyenas who can take on even the King of the Forest.

The attack of the hyenas on the Lion seems representative of the attack on hedge funds who were holding short positions in companies that were close to dying. AMC, which was close to Bankruptcy saw its share price get boosted from around $2 to $60 while the more famous compatriot GME shot up from around $5 to more than $400 bringing down a couple of very well funded hedge funds.

While we haven’t seen anything similar in India, we have seen stocks with literally zero fundamentals getting valued for thousands of crores in market cap. The level of insanity is what worries old timers as they feel that this is just a sign of the end of days. But many have been calling it too early and either underperformed the markets or worse.

While retail is seen as the weak hand, the truth is that they are often the drivers of most bubbles. Like a pyramid scheme, the better the performance, more the participation by retail investors. Since many aren’t really investing for the long run, valuations or any other historical parameter makes little difference. 

Look at some of the past price rises in assets such as Retail Estate. It was not the Institutional push that resulted in such a steep hike as much as retail interest. The reasons for the aggressive retail interest could be many, but the more they succeeded, the more attractive it seemed for those left out.

Compared to asset classes like Real Estate where there is tremendous support, investing in the market doesn’t have the same. While there is much talk about the rise of retail investors including data of new account openings, NSE data on the shareholding isn’t so optimistic. From their NSE Pulse,

Direct retail holding has remained fairly steady for more than a decade now: Not surprisingly, while retail investments through the SIP route has been rising over the last few years, barring a steady drop in FY21, direct retail participation in equity markets fell during this period—a sign of maturing markets and indirect ownership. Retail ownership of the NSE listed universe declined steadily between 2001 and 2012, but has since been steadily rising, albeit at a very modest pace, barring a drop seen in 2018 and 2019

Yet the data contradicts NSE own’s data – Net inflows by retail investors

One reason for the divergence could be the fact that much of the retail investment is going to stocks outside the Nifty 500. NSE 1000+ stocks that trade on a daily basis outside the Nifty 500. The top winners almost all come from this list too.

While the markets have been strongly bullish for nearly 1.9 years now, the commentary has been to put in their words, Cautiously Optimistic. There was first the fear of the impact of the virus themselves, the impact on the economy, the fear of the second wave and when it finally came, its impact. In between we had a skirmish at the border with China which added to the fear of an upcoming crash.

It’s in this fearful climate that the optimism of the small retail investor has performed at its best. Was this just an element of luck providing them the advantage or has the skills of retail investors matured to understand the dynamics of the market.  

Ben Carlson in his book “A Wealth of Common Sense” quotes William Bernstein from his book, The Investor’s Manifesto who says that for a retail investor to be successful in the markets, he should posses the following four skills

1. An interest in the investing process
2. Math skills
3. A firm grasp of financial history and
4. The emotional discipline to see a plan through

He then claims that he expects no more than 10 percent of the population passes muster on each of the above counts. This suggests that as few as one person in ten thousand (10 percent to the 4th power) has the full skill set.

But retail investors are not wrong all the time. When the market is trending higher, most are inline with it. The only issue is when the trend goes down, retail is the one that normally doesn’t quit. Look at the shareholding pattern of any of the stocks that have bombed big time and one can observe that the only section of shareholders who added to their shareholding are the retail investors.

The reasons that have been ascribed to the sudden shift in interest are many but the one reason has been the strong momentum that has enveloped the market. Interest in crypto currency today is 1000x more than what it was just a few years back not because investors have understood the logic but because this asset seemed like a fast way to make money.

Take for instance OpenSea, a website / platform that is the equivalent of eBay for digital art. In just around 4 years, it has now existed, it is now valued at $13.3 Billion. How long this merry is anyone’s guess but the biggest losers in all probability will be the small retail, especially those who entered it late.

What is the End Game?

One of the worries that most investors have is that markets are too high and hence not attractive to invest. Even if one looks at the Mutual Fund data, if one removes the contribution of SIP’s, the net result has been negative. 

The recent crash of covid is too near to forget but this only means that we are nowhere near the end of a bubble. George Sorors has a chart that tries to neatly explain the boom-bust phenomenon

Looking at the current market, the valuations per se makes me wonder if we are between C and D or F and G. If the former, the coming correction is an opportunity while if it’s the later, the same becomes a threat. 

The question though – how do we really know where we are and more importantly where we are headed. It’s a Million Dollar Question with no credible answers.

Based on my own Top-Down analysis, I believe that our markets still have enough legs to move higher. While the markets have risen a lot from the bottom, if you look at the larger picture, the health of the companies are way better than they were in the past. Leverage is down and while there are pockets of over-valuation especially in the new age space, much of the market isn’t.

On the other hand, does it really matter how well our companies and industries are doing if the US markets crack. At the start of 2008, companies were showing strong growth and hence being richly valued. If not for the financial crisis in the United States, our markets would have been able to achieve much higher levels even after the stampede of investors who came in for the Reliance Power public offer.

In recent weeks, hot trending stocks on the Nasdaq have taken a significant hit. But thanks to stocks such as Apple, the Index in itself has not suffered anywhere close. 

Chuck Prince, a former CEO of Citigroup has been immortalized thanks to one quote of his he gave just at the fag end of the market rally.

“When the music stops, in terms of liquidity, things will be complicated,” Prince said. “But as long as the music is playing, you’ve got to get up and dance.”

As much as he faced ridicule, the fact is that as investors, we need to continue to play till the music stops. The music may stop in the coming months or coming years or worse in the coming decades, no one can really tell it beforehand. 

As with most market rises, there has been a huge explosion in market participants. This in itself is not a cause of worry. I don’t think this is the time to be scared because the data just doesn’t agree. Data could change but so could we. Looking at the past and building a framework is a good way to make the most of the opportunities presented but still be on one’s toes if doomsday were ever to make an appearance. 

Book Review: Confessions of a Stock Broker

As someone who has spent a better part of his life around stock brokers, the very title was too attractive to miss out on. The business of brokerage has moved from being more customer centric to one where both the client and the broker barely talk anymore. The old days when clients used to arrive at the brokers office to enquire about their stocks, the broker views on the market or even general chit chat is no longer there. My best friends today though are all stock brokers – some continuing to be in business, some who have quit to become full time investors. 

Like every other industry, there have been black sheep among the broking community as well, but there have been and even today exists a few brokers who work hard for the benefit of their clients. It’s a dwindling community.

This book is in a way an autobiography of the author. At 19, he was conscripted into labor by Germany which was occupying Hungary during World War 2. His escape and how he went on to become a stockbroker in the United States forms the initial part of the story.

When I began my journey in the stock market, I associated myself with a stock broker who was a speculator. That starting point and the fact that I saw money being made in the brokerage business was what drove me to become a stock broker myself. Today I realize how wrong a starting point was and how dearly it did cost me. 

Brokers like Andrew Layni who rather than encouraging speculation by clients encouraged investing backed by research were few and far between in the pre-internet world. His strategy was based on identifying small cap stocks that fulfilled the following criteria’s

1. Fast Growth – he looked for companies that were small and yet growing rapidly.
   
2. Industry, niche, or area domination – something that Warren Buffett talks about as Moats and Peter Thiel talks about as companies that are monopolies or are market leaders in their industries.
   
3. The ability to increase earnings during recessions – note that he became a broker around 1958 and from that to say around 1982, Dow saw just one good rally – between 1962 to 1965, it doubled. The next 17 years were spent in range bound fashion.
   
4. Wall Street’s lack of familiarity with the company – even in the good old days before the internet, tracking small companies was incredibly tough. Even today, much of the broker research available is for the top 500 companies at best. Outside of Nifty 500, NSE itself has more than 1000 companies while BSE has even more. The objective here was to try to and seek companies that had not become popular and hence relatively cheap.
   
5. Ever growing repeat orders – this is something very few track but an interesting metric to understand single product companies better. 
   
6. The “cookie-cutter” factor – cookie cutter refers to the ability to mass produce something based on a fixed design. Think about franchisee companies like McDonald or Starbucks. Once they establish the basic elements, it’s easy to replicate. Closer home, Advisory and Asset Management firms can be seen as being cookie cutter. The cost of managing 100 clients or 1000 isn’t too different but the income is 10 fold.

Overall, for some one associated with stock broking, I felt a bit of nostalgia even though the book in itself and the ideas presented are pretty dated.