In a three-part series, investment and advisory group Jarden explores three key factors at play in investment decisions in 2021. In part two, Jarden CEO James Lee and director (institutional equities) James Bascand explain how the rise of retail investors is changing the markets.
It would be hard to argue that retail investors' return to the market hasn't been fantastic for stocks — adding diversity of thought and often driving moves across shares with strong volumes. We suspect some retail investors have made more money than many professionals, which should continue to support investment into markets.
Often, investing is often only half about the hard facts. The other half is about the pitch, or the story. At different times in the market cycles, one of these two themes will be more prevalent. How many times have we heard a pitch from a company looking to release a new drug, caveated by a few "if" clauses. For example: "if it works it can change the world". Or a proposal from some technology platform that will revolutionise the way we ... (you fill in the blanks).
These stocks often capture our imagination by being touted as the next great thing. In New Zealand you can't go past the Geo vs Xero dichotomy. Tech company Geo floated, quickly ran to $5 a share because it was "the next Xero", and today trades at 12c a share, give or take. But for every failure, you can point to a major success — like Xero.
When Jarden floated Xero at $1 a share, it was largely retail investors who bought it, based on a phenomenal global domination pitch from then-CEO Rod Drury.
In 1987, markets around the world were enraptured by the power of the story. No matter how insane the pitch, it would be believed, and you often got your financial advice from the local taxi driver. In 1999, internet stocks were going to change the world and the next game-changing business model was Pets.com. The business took capital from the market, including retail investors, to build pet supplies inventory, and sold product for as little as one-third of what it cost the company to buy — but via the internet — to build market share. Funnily enough, they went broke.
Today, traders buy into companies like NIO Inc because it is "like Tesla", or Bitcoin because Elon Musk bought it. It appears increasingly rare for traders to have done any more homework than that. Information is shared via Facebook and Reddit, and research is largely scoffed at as slow, old school thinking. To be fair to those same traders, they can make a lot of money if they sell out at the right time — or if they pick a company smart enough to capitalise on the momentum trade. For example, when listed companies take advantage of spikes in share prices it can, somewhat ironically, actually create value.
A favourite recent quote was from an RBC analyst who switched his view on Tesla from "Sell" to "Hold", noting that his biggest mistake had been underestimating the company's ability to take advantage of its stock price to raise capital and fund growth, or acquisitions. Tesla, in his view, was able to raise meaningful amounts of capital at the unjustifiable valuations that traders were willing to pay, and on the back of that build new plants with no need to be profitable. This access to capital at elevated valuations has accelerated its growth and therefore changed the fundamentals of the business. This is flipping the typical "success first" model on its head.
To give that some local context, it would be like the New Zealand Government just giving someone $10 billion to build a power plant. That person could charge half the normal retail price and still make their business worth a lot, as they would have a much lower return hurdle than another competitor.
The frenzy over US retailer GameStop will go down in history alongside the 17th Century Tulip Mania and the internet bubble of 1999 as a sign of investor behaviour gone mad. However, it could also be seen as a turning point where it became evident how much power investment forums and aggregated retail investors can have on the markets.
The genius for GameStop comes now, announcing a US$1 billion capital raise to fund its turnaround into an e-commerce business. That is more than the company's entire market capitalisation in December 2020. GameStop went from a loss-making bricks-and-mortar company nearing its demise, to being given a second chance courtesy of retail investors and the accessibility of shared speculation (rightly or wrongly) on social media channels.
GameStop would have had next to no chance of raising US$1b just three months ago.
What we have seen is a shift in investor behaviour in 2020, with new investors entering the market. The story behind the investment, or simply the brand of the company, has become the most important factor in their investment decision. This dynamic has seen the creation of new jobs on Wall Street, with one hedge fund (Cindicator Capital) going as far as creating a job for a Reddit-savvy trader who'll manage millions of dollars via sentiment trading from forums such as Reddit, Discord, Twitter and Facebook. The job actually required the applicant to have NO fundamental investment background.
In many ways, what happened last year was that our personal entertainment budgets merged with our investment budgets, and online platforms coupled with more free time gave us the opportunity to start down the path of investment education and participation.
Essentially, in 2019 $188b was spent on sport events and movie theatres. In 2020 that figure was $83b. More than $100b became available to be spent elsewhere, and unsurprisingly, a lot of that made its way into capital markets. This change to markets is not a small one, and for businesses that can capture the imagination of investors, the prize is being rewarded with a soaring share price from a loyal investor (fan) base at a very low cost of capital.
We are seeing many examples of irrational behaviour — from investors buying Zoom Technologies (it went from $1 to $20 and back to 30c) because they thought it was related to Zoom Video Communications, or GME.ASX because it had the same ticker code as GME.NYS (GameStop). The question we ask first is what caused this?
Three things have occurred that created this story-focused, possibly naive investment backdrop: lockdowns; government handouts; and almost zero per cent interest rates at the bank.
When investors are stuck at home, given a few thousand dollars from their government and are earning nothing from their savings, it's obvious that they look around for alternatives. And given that up to $2 trillion was saved because of a lack of spending options in the United States alone, the potential for big impacts on capital markets is clear.
While some of this is temporary and recedes once the world reopens, habits — good or bad — will likely have been formed. In New Zealand, more than 400,000 new investors have entered the market, which could see more than $2b going into our capital markets.
We will be looking out for a partial unwinding of retail investment in the markets. This has the potential to create large share price swings in the short term. In New Zealand, this volatility may be most evident in the small capitalisation shares, but also in companies like Air New Zealand — where institutional investors have played a cautious hand ahead of a large pending capital raise. Fundamentally, however, we see the return of the retail investor as a positive sustainable tailwind for markets, which challenges incumbent investors to think about investing with an additional string to the bow.
So, we have seen markets change with passive investing and new investors spending their entertainment dollars on trading names they are familiar with. But the final factor at play is an interest rate environment so low that it is encouraging people to invest. It's better to trade with full knowledge of all three factors, to understand them and to make them part of our decision-making process when investing this year.
READ MORE FROM THE SERIES:
• Part one: ETFs and financial products
• Part two: Rise of smaller investors is changing the markets
• Coming up in part three: The impact of low interest rates
• This article reflects the opinions and views at the time of publication, and is not to be relied upon as a basis for making any investment decision. Please seek specific investment advice before making any investment decision. Jarden is an NZX Firm, a broker disclosure statement is available free of charge at www.jarden.co.nz. Jarden is not a registered bank in New Zealand.