- Retail traders who are speculating on cheap companies risk getting wiped out by another stock-market crash, says Albert Edwards, a global strategist at Societe Generale.
- He says investors wrongly believe the Federal Reserve is all-powerful, and doubts that its intervention will avert another downturn of as much as 30%.
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Albert Edwards is not a fan of the retail mania sweeping through the stock market.
The Societe Generale global strategist was a vocal skeptic of the market’s run-up to the 2000 dot-com bust. He is speaking out again as he watches traders who seem hell-bent on buying after a record-breaking crash and despite ever-present economic risks.
These traders have been pulled in partly by dollar-cheap speculative companies that recently declared bankruptcy. Last year’s fee war among brokerage firms could not have come at a better time for these traders who now enjoy multiple options for free transacting.
But Edwards is most concerned about an even greater catalyst for the market rally than speculative day trading: the Federal Reserve. He maintains that the Fed has effectively turned into a help desk for investors — a savior that swoops in whenever there is trouble in markets. And he doubts that its response will be enough to actually avert a market decline that is driven by worsening economic fundamentals.
“I believe this almost 50% equity rally from the March 23 low will fail because I don’t think the Fed is omnipotent, as most people believe,” Edwards said in a recent note.
“I think despite more and more liquidity thrown at the markets, the fundamentals will ultimately dominate, and the market will sink to new cycle lows, even after the Fed commences buying S&P 500 ETFs when/if the S&P slides below 2000.”
Such a slide would be yet another 30 percent-plus drop from current levels, and may wipe out the newcomer day traders Edwards calls “zombie” investors.
Retail traders are on a roll
For now, credit must be given where it is due: these rookie traders are beating professional money managers at their game so far this year, according to Goldman Sachs data. A basket of the most popular stocks among retail traders outperformed the prime picks of both mutual fund and hedge fund managers by more than 15 percentage points.
The issue for Edwards and other observers is that the force that sucked these traders into the market could spit them out with the same ferocity. And in true stock-market fashion, there will be no advance warning to take profits.
Andrew Lapthorne, who heads up Societe Generale’s quantitative research team, also flagged this very concern even while lauding the impeccable timing of retail traders.
“Hyman Minsky describes the five phases of a bubble as: displacement, boom, euphoria, distress and panic – and it seems we are cycling through these phases in record time this year,” Lapthorne said in a recent client note.
Lapthorne’s team unearthed further evidence of speculative retail buying by digging into data from the free-trading platform Robinhood.
They found that traders were piling into small-cap companies with low share prices and weak balance sheets. Such companies typically bounce hard after crashes because they fall to the lowest depths. But this time, the gains are abnormally high.
Societe Generale
The caveat with this analysis is that Robinhood traders constitute a fraction of the overall marketplace, and so the impact of their dealings on broader moves must be put into proper perspective.
However, Edwards’ takeaway from his colleague’s work remains that directionally speaking, the broader market is hurtling towards euphoria — and inexperienced traders who piled in will get the short end of the stick.
To further back up his view, he cited data from Sundial Capital Research that shows options traders who exchange 10 contracts or fewer spent a record 52% of their volumes speculating on higher prices in recent weeks. Their purchases of call options tied with the most frenzied weeks for the stock market in 2000.
Edwards, who called the dot-com crash back then, now has a simple message for these speculators: buyer beware.
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