Bloomberg’s Lu Wang wrote a piece on the 7th noting that “….risk-taking traders roared back to life….where frenzied selling eventually gives way to a bounce whose size defies logical expectations.” The KCR research team has been relentless in suggesting investors avoid the mania. Our research suggests retail has been seduced by the most promotional market environment we have seen in our 25+ year careers.
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The history of manias suggests that when investing becomes a form of entertainment it is rarely good for retail investors. The chart offers evidence of how aggressive stock speculators are today.
The KCR team ran a screen using daily data of all stocks in the market since 1989. We identified all the firms that had their market price double in 5 days or less. So far in 2021, stocks with price movements of >100% in just 5 trading days have grown to $140bn in market cap.
The values you see below dwarf the numbers seen at the peak of the internet mania in 2000. To draft off Ms. Wang’s comment above, we also believe price rises of this magnitude do, indeed, defy logic.
The chart below shows the number of stocks that have doubled in 5 days or less. What is remarkable in this cycle is the explosion in valuations seen year to date, has come from only 18 stocks. Said differently, 18 stocks have risen by >100% in just 5 days which created $140bn in market cap. This was not some collection of penny stocks.
As explained below, we believe this is due to promoters controlling the float for some of the market’s most speculative firms.
How does this happen? Consider Robinhood, a firm that listed only $2bn of stock on its IPO which valued the firm at $38bn. While “democratizing finance” and attacking Warren Buffett and Charlie Munger, the firm gave retail investors a 20% direct allocation of their ~55ml share IPO.
After enjoying an outsized pop after the IPO, the stock has collapsed by over -42% as of this writing. Longtime readers of KCR’s work are not surprised by this performance. The company just lost -$1.2bn on $340ml in sales in its most recent quarter.
How it is still valued at nearly $20bn is beyond our understanding. Apparently, the $1.3 billion paid to management in stock compensation in a single quarter still isn’t an expense. Sorry. We digress.
Yet KCR believes the reasons are far simpler as we explained in this 10-second post on the HOOD IPO. After selling retail and other investors ~55 million shares on the IPO, the company’s lockup expired. This allowed a staggering 567 million incremental shares to be sold into the market. Over 10x the IPO amount.
Hearing about IPOs ambushing retail investors is hardly new. The KCR team is not focusing on Robinhood out of any intrinsic antipathy. We bring it up because HOOD’s IPO effectively pitted the most sophisticated bankers vs retail investors.
Predictably, retail has lost. Even more unfortunate is the fact that Robinhood is a stock that benefits from the volume of stocks that are traded.
We wrote a historically-informed piece on why stocks with high relative volume today should be viewed with suspicion. Titled What Does Volume Mean in Stocks the piece gave explicit evidence of the dangerous nature of the market’s most traded stocks.
In the below, we will try to avoid butchering the phenomenal work of Berkeley professor Terrance Odean and UC Davis’ Brad Barber to explain why retail market participants tend to invest in securities with extreme returns, like the ones we showed above, agnostic of fundamental merit.
Terrance Odean & Brad Barber: An Attention Investment Model
In their work, The Effect of Attention and News on the Buying Behavior of Individual and Institutional Investors, the researchers provide evidence that individual investors tend to be buyers of stocks that are getting “attention.” Lacking the time or resources to properly filter 1,000s of securities, many investors are naturally drawn to stocks that are making headlines. These headlines are often due to extreme one-day returns or abnormally high volume and therefore likely to be newsworthy and interesting.
Andrei Shleifer’s work showed markets are anything but efficient. This paper adds to that work by showing investors’ buy decisions are often sourced from the “loudest” stocks. Hardly an “efficient” process.
Having bounded rationality, human beings can only process so much information. While not immune to speculation by any means, institutional investors (and particularly value investors) who have the resources and a heavy emphasis on fundamental value, exhibit almost the perfectly inverse behavior.
Retail vs. Institutional Investors
The chart below shows how volume impacts the order flow of retail investors and institutional value investors. Each bar shows the “order imbalance” defined as the number of purchase orders minus the number of sell orders divided by the total number of trades. A positive number means there are more buys than sells. A negative number indicates a group is entering more sell orders than buy orders.
The navy blue bars represent retail while the light blue bars represent institutional value investors. The bars on the left show how the two groups behave in the stocks with the lowest volume. The bars on the far right show how the two groups behave with stocks that have the highest volume trading.
The first navy blue bar on the left shows that retail investors overwhelmingly tend to sell the lowest volume stocks. Stocks that are barely trading have nothing exciting going on. In contrast, the first light blue bar shows that institutional value investors are overwhelmingly interested in buying stocks that have nothing exciting going on.
Now look at the right two bars. What happens? The situation reverses.
Retail investors love to buy stocks that are experiencing huge volumes. There’s something going on! It gets their attention and they want to be involved.
Stocks with High Volume Attract Retail but NOT Institutional Value Investors
In the interests of brevity, we have omitted the many other fascinating points in this paper. We believe the lessons it holds have never been as important as today. The explanation of why retail investors have different behaviors for buying vs. selling is utterly fascinating.
The data is pretty clear: the disposition effect is very real. We sell our winners and use the proceeds to chase rising shiny objects and, worse, double-down on our losers.
Speculation vs Hedging
The KCR team is deeply sympathetic to irate retail investors. We believe their interests would be much better served by working with an individual investment advisor at an RIA. Negative real-returns on bonds and the speculative state of financial markets make today’s investment environment dangerous in our view and succeptible to bear market trading strategies.
Once prudent investors who owned thoughtfully managed mutual funds and held diversified portfolios have suddenly become frenetic buyers and sellers of stocks. Even many hedge funds, once adherents of being long and short in the interests of reducing drawdowns have become performance chasing vehicles. The KCR team can only wonder which vaunted prophets today will come under scrutiny from the Securities and Exchange Commission.
In the meantime: while others make promises we urge prudence and counsel from reputable providers of investment advice.
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December 10, 2021 |
| Authors: Matthew Malgari, Nathan Przybylo, Dr. Sanjeev Bhojraj and John Durkin
December 10, 2021
Authors: Matthew Malgari, Nathan Przybylo, Dr. Sanjeev Bhojraj and John Durkin