Why retail liquidity is key to our markets

There was a quote that my East-ender great grandmother apparently always used to say when she was talking about infidelity (particularly in a man)

If one [girl] is not enough… a dozen won’t be too few

As much as her sunny optimism, or lack thereof, still makes me laugh there is some real wisdom in this saying beyond fidelity. In short, when people stray & get away with it… they will keep doing it.

There are some parallels between this and other risk-taking behaviours, notably investing. Below is a short snapshot of where I feel things are risky & where it is not risky.

Valuations are not the main risk, retail liquidity drying up is the risk

Every day we see lots of headlines about shares “record high” valuations and generally, you react differently depending upon if you are invested or not.

Parking that discussion for a bit, I think the more important point is the growth in participation of retail investors (a great phenomenon) and the growth in leveraged positions (great; if kept under control). So what do we know about retail investors

• They're new to the market: Deutsche Bank survey found that almost half of US retail investors were completely new to the markets in the past year

• They trade a lot:The average e-trade or Ameritrade account trades between 10-18x a year; (which is much more than institutional investors)

• They're levered, but are gearing up at slower rate: Investors are trading on record levels of margin loans, however, they dialled down this level in Jul'21

• It is a bigger driver in US than Aus: Australian share market is more wedded to the old school SMSF

But instead of taking my word for it - here are some graphs to show you

1) From a list of US funds; retail is +50% of US fund managers AUM

2) Retail investors now represent 2x the trade volume of Mutual Funds or Hedge Funds

3) Because retail things want growth; they are increasingly using leverage (but this trend is slowing somewhat)

4) The trend is less intense in Australia (although there are classification differences)

So what are my takeaways from all of that

1. Retail investors collectively yanking liquidity (trading volume not just value) is a bigger risk for Institutional capital than you think

2. Valuations alone are probably not going to drive that decision given retail investors have jumped into the markets at higher levels (last 12 months)

3. There is evidence of retail investors reducing leverage which is generally a good thing, however, it is not yet conclusive

4. Australia will probably follow the US even if the investor profile differs somewhat