To the untrained eye, the collapse in global equities between late-February and mid-March may have looked like a once-in-a-lifetime opportunity – the chance to snap-up quality stocks at rock-bottom prices.
In the six weeks since CoreData began tracking the impact of COVID-19 on the sentiment and behaviour of Australians, we have seen an increasing proportion of investors buying or intending to buy undervalued equities – a strategy commonly known as trying to ‘buy the dip’.
Analysis released by ASIC in early May documented a rise in speculative retail trading, finding increases in short-term strategies, risk exposure and attempts to time price trends. The report notes that even professional traders would find it difficult to ‘time’ the market amidst current volatility, with retail investors who chase quick profits tending to perform poorly even in the most suitable conditions.
Buying the dip and timing the market
According to CoreData’s most recent COVID-19 Pulse Check, more than one in 10 Australians (11.4 per cent) have already purchased discounted shares, hoping to benefit from an eventual recovery, and almost a third (30.2 per cent) are still planning to do so in the near future.
The primary reason offered by those that will not attempt to buy ‘cheap stocks’ is that they do not have sufficient funds to do so (69.4 per cent). Only one in five (21.6 per cent) say it is too risky, and even fewer recognise that timing the market does not work (7.9 per cent).
Irrational exuberance and traditional overconfidence may be rearing their ugly heads, with most of those ‘buying the dip’ claiming it is an opportunity to buy at a discount (75.0 per cent), and, remarkably, more investors basing their actions on recommendation from a friend or family member (12.3 per cent) than a financial planner (7.1 per cent) or other market professional (5.7 per cent).
In addition to an increased number of new retail accounts and reactivated dormant ones, ASIC has observed a greater utilisation of highly geared and complex products, such as Contracts For Difference or CFDs. The magnified investment exposure offered by these products can potentially provide the impetus for catastrophic losses of capital if used incorrectly by untrained investors.
SelfWealth, a trading platform growing in popularity amongst retail traders because of its low brokerage fees, reported continued high frequency buying and selling of ETFs in April, which suggests investors are actively trading market instruments that were initially designed for long-term use.
Of greater concern, however, is the increased popularity in leveraged and short-leveraged ETFs, as well as buying activity in depressed stocks in aviation and crude oil. Whilst contrarian investing is not new, the bleak outlook for both industries suggests retail is being sucked into the hardest hit stocks, assuming an eventual return to pre-COVID-19 levels.
Markets move higher, leaving behind Buffet and Berkshire
The recent spike in trading activity helped the ASX to climb off lows through April and post its best month on record. Similar results have also been recorded elsewhere, with major indices in the US retracing approximately half of the losses initially suffered through March.
But the growth in activity has come at a time when traditional fundamentals continue to point to a further fall in prices. Analysts are predicting a continued decline in earnings for US-listed companies through 2020, with revised down estimates but recovering stock prices pushing price-to-earnings (P/E) ratios to abnormally high levels.
Even the famous “Buffet Indicator”, named after investor Warren Buffet, remains indicative of overvalued stocks.
Buffet’s famed adage, “Be fearful when others are greedy, and greedy when others are fearful”, is often quoted by retail traders seeking to justify their contrarian theses. But first quarter reporting revealed that the famous investor and his company have mostly sat idle during the COVID-19 crisis, hoarding cash and exiting losing positions in major airlines, rather than spending big as was the case during the Global Financial Crisis.
This begs the question; if Buffet does not see markets as attractive at current prices, why does the average Mum and Dad trader?
The harsh reality
According to CoreData’s research, Australian investors are pessimistic on the short-term economic outlook, with most expecting the economy (74.4 per cent) to grow at a slower rate and investment markets (50.9 per cent) to be worse in the next quarter. Even as many of them are buying, more than half (51.7 per cent) expect Australian equities to underperform in the next quarter, with even greater negativity held towards international stocks (62.3 per cent).
The ultimate problem lies in the inherent nature of markets – every trade has two sides. For every uninformed or imperfect retail trade, there is often a better informed, professional investor on the opposing side. Recent trading activity has produced little benefit according to ASIC, with shares declining following days where retail investors were a net buyer and rising after days where they were net sellers.
In a time when managed funds, institutions, and even super funds, are eager to exit their positions and boost liquidity, it appears more than likely that many retail traders are being taken advantage of. These short-term and overexposed positions will lead to inevitable losses for the average investor, and, to quote ASIC, “losses that could not happen at a worse time for many families”.
