To say the financial world is fascinated by the prospect of retail investors driving sector/style rotations via their Robinhood accounts would be an understatement.
This has become a veritable obsession for market participants and the sell-side has most assuredly picked up on it. Almost every bank has touched on this topic du jour at least once over the past two weeks, and in some cases multiple times.
It’s important to give credit where it’s due. Quite a bit of the fascination with this story is clearly attributable to Bloomberg’s Sarah Ponczek, who has covered it exhaustively, sparking something of a cottage industry in analysis of Robinhood trading.
Regular readers know my position on this: It’s a great story, and there’s probably a great deal we can learn about investor psychology and behavioral economics from parsing the data made available by “Robintrack”.
But when it comes to the direction of the overall market, and even to sector/style rotations, it would be a mistake to obsess too much over this. There’s not enough “AUM” (and I’m not even sure it makes sense to use that term here) behind these trades to matter.
It’s not a coincidence that an uptick in “small batch” (I like to toss in bourbon references where possible) options trading has coincided with an apparent rush into “insolvency stocks” by newly-christened day traders, some of whom are substituting stocks and options for sports betting, at least according to anecdotal accounts.
Penny stocks (and shares of companies which used to be viable, but are now insolvent and thus trade like penny stocks) are really just options. Typically, the viability of the firms represented by penny stocks is highly questionable — in some cases, there really is no “business” (to speak of) at all. That makes “traditional” penny stocks not unlike the shares of formerly viable companies which are now insolvent. Yes, it’s possible to conjure a scenario where some heaven-sent fundamental catalyst (a deus ex machina) comes calling and you can score Bitcoin-like returns. But more often, “successful” penny stock trading involves doubling or tripling your money on shares you bought for what might as well be nothing – for “pennies”, as it were.
SocGen’s Andrew Lapthorne underscores this point in a lengthy note out Monday, analyzing the Robinhood trades through a factor lens. To with, from Lapthorne:
If we were to define the typical behaviour of a highly speculative retail investor, it would be buying stocks with a low share price, or those that have fallen by a lot in a short amount of time. Indeed, the ‘optionality’ in these stocks can be so high we sometimes use it as a risk factor, and ten years ago we demonstrated how such an “optionality” factor could help us manage reversal risk in long/short price momentum portfolios. The basic concept behind this factor is that when a share price approaches zero quickly, it takes take on an option-like pay-off profile, i.e. the upside potential far outweighs the cost of the option.
That, in short, is what’s going on with the Robinhood story.
Lapthorne delves into the dynamics using the Hertz example, which has become the poster child for this behavior among retail traders, who are either extraordinarily naive, accidental geniuses or, more likely, some combination of both. Here’s Lapthorne:
Let’s assume you have zero information on a stock apart from the price chart, which shows that it bottomed intraday at below 50c versus its 2020 peak of more than $20. So for a 50c outlay you could gain almost $20 — an incredible return approaching 4000%. These potential lottery ticket returns can generate a spike in volumes, which has occurred in the case of Hertz Group, but which in turn pushes the share price up to the extent that the lottery ticket pay-off drops away. So now you are now having to pay $5.50 to get a potential gain of $14.50, so the potential upside is now at “just” over 260% — the ‘option’ costs more but is worth less.
Of course, the problem here is that this is an “option” on nothing, something SocGen goes on to underscore in amusingly dry terms.
“Now of course this is all bizarre as there is no obvious reason to expect Hertz Group to regain its previous high — after all it has filed under Chapter XI”, Lapthorne writes, adding that “if you buy an option that expires worthless you have lost all your money”.
That is why I have generally eschewed coverage of this story, although I did indulge in a trio of posts, including the one linked above and another over the weekend (here).
These are, generally speaking, nonsense trades. They are akin to penny stocks and OTM calls, but only to a point. It’s not at all obvious what you have a claim on with these shares. These trades are more like cryptocurrency speculation than they are penny stock trading or buying cheap calls. If pressed, you couldn’t say exactly what it is that you’re entitled to, other than selling to someone sillier than yourself. (Forgive me for lapsing into pejoratives.)
That act of selling something which isn’t just intrinsically worthless now, but will always be intrinsically worthless, for a profit, isn’t really the same thing as selling (to close) a call option which has appreciated prior to expiry. That option could, eventually, have intrinsic value. It is also different from owning shares of a probably-insolvent “traditional” penny stock. That’s because “probably insolvent” is different than “definitely insolvent”.
SocGen’s Lapthorne goes on to make a series of additional, related observations about recent trends in low quality names over the latter part of the post-COVID-crash rally. To wit:
Yes, those shares that have fallen most in a crash tend to bounce back strongest, but the price movement in distressed US small caps over the past couple of weeks was so strong it propelled them back into positive territory year-to-date and for a while had them beating the Nasdaq. Now we should caveat that these charts take no account of liquidity, market impact, or trading costs (which would be significant) — but the point of the chart is to illustrate what has been going on.
The chart which will invariably be cited on Monday across financial media outlets and almost surely on “financial Twitter” (“FinTwit”, for short), simply illustrates that when it comes to the Robinhood crowd and US small-caps, retail has achieved dip-buying perfection.
“For all the mocking of Robinhood investors, their timing back into the market looks impeccable, with a significant pick-up in holdings as equity markets bottomed in mid-March”, Lapthorne goes on to say, before reminding readers that the data “comes with many caveats”.
Speaking of caveats, I think it’s important to note that not all analysis of these trends is well-meaning and constructive.
The SocGen note cited above is great (Andrew’s work is always highly engaging and enjoyable), and Bloomberg’s coverage is similarly fantastic.
But some of the coverage seen across other, less reputable corners, carries derogatory overtones, and I don’t mean that in the sense of retail investors being characterized as bagholders (that’s just standard criticism, and the retail crowd often revels in it themselves).
Rather, what I mean is that some portals have tacitly used the Robinhood data to suggest that unemployment benefits and other virus relief assistance is being misused by lower-income individuals and families, who, according to the implicit narrative, are channeling taxpayer money into stock speculation. The read-through is that benefits should stop and that the poor are grifting freeloaders. As usual, I won’t call out any specific portals, as I have no need to deride others to legitimize myself. Just know that this narrative exists.
So, why is that a problematic narrative? Well, first, because based on the data everyone seems to be citing, it isn’t true.
I make no claims as to having evaluated the accuracy or even the methodology of this data, but the table and color below is from Envestnet Yodlee and, again, it’s been cited by several outlets (you can peruse it all for yourself here.)
Spend in households which received stimulus vs those that did not (yet receive).
Top 7 Overall Categories which saw highest week over week changes by households which received stimulus vs those that did not (yet receive).
The categories above refer to spend/transfer outs of funds from bank accounts after receipt of stimulus. The rank ordering is based on the difference in WoW %age increase between the two user groups that were studied.
Transfer to Savings accounts/deposits by Stimulus recipients saw the highest rate of change for 5 of the income groups compared to those who had yet received it. This does not include the stimulus money that was retained by the users without actively being transferred for savings.
ATM/Cash withdrawals by people in income segment of <$35K who received stimulus money was ~200% higher WoW
Assuming that data is reliable and worth citing (and I have no reason to believe it isn’t), there are only two real trends worth mentioning. The first is obviously that savings exploded for all income categories except top earners. The second (related) trend is that people needed cash, as evidenced by ATM withdrawals taking the #2 slot for all but the top two income categories.
“Securities trading” isn’t even mentioned in the category of those making $35,000 per year or less. This data does not suggest that those who needed the stimulus the most are squandering government aid on stock trading. Maybe other data does. But this data doesn’t. Period.
The only additional thing I would add is that some of the money earmarked for virus relief is guaranteed to be misspent. Indeed, we’ve already seen that with some Paycheck Protection Program loans. I’m not denying that, and indeed I’ve covered it. But the question is whether there is a trend in enhanced benefits to poor families being squandered or otherwise misused. I think readers will agree that the notion of widespread Robinhood speculation by families making $35,000 per year or less is patently absurd.
I’m going to leave that discussion there, and readers can make of it what they will, but I would add that it’s part of the overall debate around the extension of enhanced benefits (more here).
Getting back to SocGen’s note, Lapthorne provides dozens of additional insights and there simply isn’t room to cover them all, so I’ll just leave you with a couple of quick excerpts from his concluding remarks which are, as ever, well done.
Credit where credit is due — as retail investors, based on the Robinhood dataset, have charged into the market at its very inflection point. Of course only time will tell if this has been profitable in the long run.
However, 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. And when it comes to Hertz Group it now seems they can radically change how a company tries to finance itself out of Chapter XI!