China Has a Lesson for Robinhood Traders in the U.S.

(Bloomberg Opinion) -- Covid-19 has awoken an army of retail investors. They now account for a fifth of the U.S. stock market’s volume, doubling their presence from a decade earlier. Day traders are even dabbling in exotic products, from thematic exchange-traded funds to short-dated call options on Big Tech stocks. 

This is a remarkable shift in market composition. Judging by turnover, leverage deployed and new account openings at online brokerages such as Robinhood Markets Inc., the U.S. is starting to resemble China, where retail investors can account for as much as 80% of total trading. 

Money managers may not like this frenzy, because they’re no longer in the driver’s seat and don't always understand the market’s dynamics. But higher retail participation is a good thing overall, especially since passive funds have already surpassed active ones in total assets under management. Day traders sifting through online chat rooms make pricing more efficient.

Take China, for example. Despite its reputation for exuberant turnover, the mainland market can be surprisingly rational. What drove stock returns most over the past three years has been earnings revisions, followed by profitability and momentum, Bloomberg’s factor analysis shows. Chinese investors also pay attention to what equity analysts have to say. If you constructed an equally weighted portfolio, buying the top 20th percentile of stocks that had the most positive changes in target prices, while shorting the bottom 20th percentile, you would earn more than a 60% cumulative return over three years.  

The same can’t be said in the U.S., where money managers overwhelmingly chased growth stocks, tossing aside important financial signals that China’s day traders valued, such as earnings revisions or the health of a company’s balance sheet. This might explain why the mainland stock market was more resilient during the global selloff in March. Back then, cash was king. 

One concern is that retail fervor could overheat things. Back in 2015, China’s mom-and-pop investors generated a gravity-defying bubble, doubling the blue-chip CSI 300 Index in just eight months, before an equally furious tumble. In 2020, their American peers have made a good run for it too, with the S&P 500 up over 60% from its March low.

But fear not, there isn't enough evidence to suggest this will all end in tears. Every week since 1987, the American Investor Sentiment Survey has been asking retail traders the same simple question: How they feel the stock market will be over the next six months —  bullish, neutral or bearish. There have been 115 times when the bull-bear spread exceeded 25% — that is, when respondents have been overwhelmingly bullish — with the latest in November, according to CLSA Ltd. Looking at the S&P’s performance 10 to 90 days after these episodes, such enthusiasm hasn't been an indicator of the market topping, the brokerage finds. In fact, on average, stocks were up 1.6% three months later. Only a third of these occurrences ended up with negative returns.  

U.S. investors can get nervous by China comparisons, because the mainland market has its share of anomalies, from convertible-bond trading frenzies to dramatic first-day pops of initial public offerings. But these are usually the result of poor marketplace rules that savvy retail investors took advantage of — not something a mature, developed market like the U.S. has to worry about. Retail money isn’t dumb money; it only brings out the animal spirits. 

Rebalancing monthly.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Shuli Ren is a Bloomberg Opinion columnist covering Asian markets. She previously wrote on markets for Barron's, following a career as an investment banker, and is a CFA charterholder.

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