Over the past four months there has been an explosion in new retail trading accounts. Robinhood, the stock trading app popular amongst millennials, opened a record 3 million new accounts in the first quarter. Most of these accounts are owned by “Newbies” who lack trading expertise and/or significant securities analysis skills. The surge in retail trading is in part being fueled by zero transactions costs, speculation, and the shutdown of sports betting and other gambling outlets.

Commission rates have been trending lower since “May Day” in 1975, when brokerage rates were deregulated. This paved the way for discount brokers, like Schwab and Fidelity, to compete on price. As we wrote about in December, it’s worth understanding how companies which formerly earned revenue from commissions can survive in today’s zero-commission environment. Not every broker is financially strong enough to offer zero-cost trading.

The surge in retail trading/speculation has amplified the market rotation toward cyclical companies and stocks most affected by the global pandemic, such as airlines and casinos.  These economically sensitive companies have been most negatively impacted by COVID-19 concerns and arguably offer significant upside (and risk) as the economy re-opens. Additionally, Newbies and other speculative investors have flocked towards “penny stocks” and companies in bankruptcy, such as Hertz Global Holdings and J.C. Penny because they are essentially a spin of the roulette wheel. Most of these stocks are unquestionably completely worthless, but some prices have multiplied as speculators pile into these gambles betting another trader will pay more. To the extent bankrupt companies are able to sell equity that eventually will likely have no value, bond holders benefit at the expense of novice stock speculators.

A popular Wall Street narrative also suggests Newbies are turning to stock and options markets for their gambling fix. The global pandemic has shut down professional sports, casino sports books, and table gaming across the country. Ironically, according to Goldman Sachs research, the most popular stock among retail investors is Penn Nation Gaming, which owns a stake in Barstool Sports – a bet on the speed and breadth of the reopening. In options markets (the ultimate binary trade), trades under 10 contracts (considered small and attributed to retail traders) have grown to nearly 15% of all options trading volume from almost imperceptible a few months ago. This underscores a troubling reality that has been persistent for years: many retail investors, who do not understand how to value public companies’ stocks, cannot differentiate between owning great enterprises and playing games of chance. When they approach investing this way, odds still favor “the house”. The key difference is that the house is not a casino but a group of knowledgeable professionals on the other side of the trade, selling shares of bankrupt companies and those with weak fundamentals. Caveat emptor.

Peloton is a research-driven investment management firm. We analyze the underlying business of every stock we own and trade on an institutional platform. Investing is a full-time job. Only time will tell if the Newbies and other retail investors will be profitable in the long run.

 

Disclosures

Past performance is no guarantee of future results.  Peloton does not own the common stock of Charles Schwab Corp. (SCHW), Hertz Global Holdings (HTZ) or J.C. Penny Co. Inc. (JCPNQ). For a complete list of Peloton equity holdings, please refer to our current 13F filing. Investing involves risk, including possible loss of principal.  Diversification may not protect against market risk or loss of principal.  The opinions expressed above should be construed as neither investment advice nor a solicitation to buy or sell securities.  Actual investor results may vary.

 Not FDIC Insured – No Bank Guarantee – May Lose Value