It is an short excerpt from my 2020 Q4 letter [Link], but it felt like long time a ago since the GameStop story folds out. I think this new phenomenon may have profound impact to the market structure. For example, how do we define a “right” price, and what is “market manipulation” exactly? Historically, price manipulation happened when few entities comer the market and set price by transacting between colluded parties. In that way, such price is not “right” because it’s not agreed by a widely participated market (i.e. an authoritarian price). If the “right” price is defined as the price agreed by majority in a widely participated market (i.e. a democratic price), isn’t the currently price of GameStop (closed at $347.51 on 1/27/2021) a “right” price? and if it’s a “right” price, where is the “manipulation”?
One hallmark of US equity market in 2020 is what I called the great “Retailization”, where the asset pricing function seemed to heavily shift to the hands of retail investors. Lately, I was able to get hands on a proprietary dataset which confirmed this phenomenon. On left chart below, you can see the retail trades in % of total equity market trades held at a level of 12% from 2017 to early 2020, then jumped up to a level of 25% in late 2020.
Additionally, retail is not “dumb” money anymore! At least judging from short term return perspective. On the right-hand side chart below, you can see a hypothetical one day holding period L/S strategy to buy the 10% most bought stocks by retail investors on that day and short the 10% most sold stocks at the close and exit positions at the next close. The most obvious thing you would notice is the clear infection point in March 2020 when US shut down for the pandemic. Even before that, this signal still predicts positive one day forward return (i.e., the prices follow what retail investors flow), yet in a milder form (13~% annualized return). Since March 2020, such signal started to show stellar predictive power, leading to a 97% annualized return! This is a solid confirmation, using data, that Mr. Market now is basically a retail trader.
Now that we see the “what”, it is important to think about the “why” (it happened), and the “how” (to prepare for it). There is more retail participation as the market share analysis shows, but there is still 75~% of institutional flow. However, if we try to break it further down by active & passive flow, and assuming passive institutional flow are not pricing assets, we can argue retail now has a much stronger hand against active institutional flow, especially in certain sector (e.g. tech), or certain stocks (e.g. Tesla).
Looking forward, I start to think about the implication, here are what could happen (or may already be happening):
- The rise of a new breed of investor, who make “profiting in stock market” seemingly easy.
- The rise of star fund managers using new paradigms.
- Capital Market are transformed by an influx of new personnel who only had experience of a prolonged bull market.
In case you have not noticed, I just copied some description for the Nifty Fifty bubble in 60s to 70s. The parallel between now and then seems obvious, yet I think there are a few nuances in today’s market: 1) I believe businesses today have a sounder fundamental, which probably only seen in the last Industry Revolution; & 2) The speed of information is exponentially faster than in the 70s. This leads to me to think that we may be at the beginning of a larger “bubble” than Nifty Fifty, yet in a faster pace. I think that new paradigms today have their merits but will very possibly be pushed to extreme by elevated retail participation. One key lesson from Nifty Fifty era is that valuation still matters even though one can do fine in long term if holding great businesses through a huge bubble.