Adaptation

Can you blame them?

That’s what I’d ask of anyone inclined to criticize retail investors and sundry day-traders for their generally unshakable conviction when it comes to buying stocks at the first sign of significant weakness.

On Black Friday, while many Americans were shopping for another flatscreen they don’t need, the “dumb” money was busy buying at least a couple billion in equity ETFs, according to Vanda Research. They were promptly rewarded the very next session.

As I wrote in “Animal Spirits And Gunslingers,” retail dip-buying is just the “stupid” version of vol-selling. In either case, it’s the same Pavlovian response function. Monday’s rally in US shares, I gently suggested, would “only reinforce the classical conditioning.”

Small wonder, then, that Vanda’s data showed more dip-buying from the same investor cohort on Tuesday. I’d say it must have felt like back-to-back Black Friday sales for the “YOLO” contingent, but that joke would be too obvious.

On Wednesday, Bloomberg cited Vanda again in reporting that retail bought a net $2.2 billion during Tuesday’s swoon, the most ever, bringing the total over the past week to nearly $7.5 billion.

There wasn’t anything complicated about the wagers. Day-traders poured a combined $440 million into SPY and QQQ, according to the same data. Vanda’s Giacomo Pierantoni told Bloomberg’s Bailey Lipschultz that retail money is “usually contrarian.”

You don’t know whether to chuckle or… well, laugh.

On one hand, there isn’t much that’s “contrarian” about buying on weakness in the post-financial crisis era. Like the GEICO commercial says, “It’s what you do.”

On the other hand, analysts and strategists spent the past 72 hours penning laborious missives and sketching every conceivable branch on the decision tree depicting the interplay between the Fed’s reaction function and a new, more transmissible COVID variant. The message: If you’re smart, you’re wary.

While useful for professionals, the Reddit crowd couldn’t care less about such nuance.

When Jerome Powell triggered a rout on Tuesday by suggesting the Fed feels boxed in by inflation and may be inclined to proceed with an accelerated taper irrespective of Omicron, the yield curve pancaked as “the market” (whatever that even means in 2021) panicked about a prospective policy error.

Retail investors, by contrast, just saw a second opportunity in three sessions to make a quick buck. And they did just that on Wednesday, assuming even a modicum of competent execution. (US stocks faded in afternoon trading, but the morning rally provided ample opportunities to capitalize on dips bought the previous session.)

Note that this is a crowd comprised at least in part of crypto fanatics, Reddit regulars and meme stock mavens. A 2% swing in either direction likely seems very tame — placid, even, by comparison to some of the other “assets” in their “portfolios.”

Powell on Wednesday said the Fed would “adapt” to an environment in which inflation is more “persistent.” As I’ve repeatedly emphasized, such a macro backdrop would prove exceptionally challenging for many multi-asset portfolios, which depend on a predictably negative stock-bond correlation.

As the figure (above from Goldman) shows, that assumption is hardly a given, historically speaking. It’s a product of a two-decade period of subdued macro vol and a concurrent four-decade bond bull market.

If macro vol picks up as a result of persistently high (and unpredictable) inflation, multi-asset investors will struggle to “adapt,” in part because monetary policy’s adaptation process will be highly disruptive.

It would be highly amusing if, by virtue of steel nerves tempered by years of crypto trading and meme stock adventures, Darwinian selection ends up favoring retail day-traders and pushing everyone else to the brink of extinction.