- Bullish sentiment has returned in a big way among retail investors as they've started the year piling record amounts into stocks.
- Like the meme-stock boom of 2021, investors are picking risky, speculative assets, despite those being the biggest losers during last year's rising-rate environment.
Retail investors are partying like it's 2021.
The everyday traders that powered the meme-stock frenzy of two years ago are back, rebuffing Fed Chair Jerome Powell's hawkishness and helping push equities higher after a dismal 2022.
Retail investors have been spending a record $1.5 billion a day on stocks this year, according to Vanda Research, helping the S&P 500 climb nearly 5% year-to-date, and powering the Nasdaq 100 more than 11% higher.
While the bullishness matches the meme-stock frenzy of yesteryear, the macroeconomic picture couldn't be more different.
Bullish sentiment and a bleak economic outlook
In the early days of the COVID-19 pandemic retail investors, flush with stimulus money from the government and rock-bottom interest rates, bet big on a handful of struggling companies including GameStop, AMC, and Bed Bath & Beyond. These bets ended in big losses for some hedge funds that were squeezed while attempting to short these names.
Soon after, though, retail investors pulled out of the market at a furious pace as inflation climbed, the central bank raised interest rates, and risk appetite evaporated. Those that remained endured a brutal rout in 2022.
But fast forward to the last several weeks, and the retail cohort appears to be back, armed with a record $1.8 trillion in cash that's burning a hole in their pockets. According to Fundstrat's Tom Lee, that number balloons to nearly $5 trillion if you include the $3 trillion sitting in money market funds held by institutional investors.
Gene Goldman, chief investment officer for Cetera Investment Management, told Insider that retail investors bid up stocks in January because optimism for an economic soft-landing ticked up — despite the Fed's insistence that more tough monetary policy is still on the way.
"With all of these headwinds, retail investors are jumping in on maybe some ill-conceived optimism," Goldman said, adding that markets are pricing in an economic recovery that may not arrive until much later than expected.
DataTrek Research highlighted this month that the New York Fed's Recession Probabilities Model puts the odds of a downturn at 57%, the highest it's been since the early 1980s.
"No one seems to care, probably because Fed-induced recessions should have Fed-induced recoveries," DataTrek cofounder Nicholas Colas said.
Speculative bets are back
Some of what retail investors are buying has troubled observers. The euphoria has led analysts to describe their moves as deliberately taunting the Fed, flipping the market upside down as the riskiest assets rise in the face of the central bank's efforts to rein in market enthusiasm.
"There is an old adage 'don't fight the Fed,' but this behavior is not just fighting but also taunting the Fed with crypto, meme stocks, and unprofitable companies responding best to Fed communications," JPMorgan's Marko Kolanovic wrote in a recent note.
Cryptocurrency, electric-vehicle companies, and speculative growth stocks — the names that took the biggest losses last year — have rallied to start 2023. Bitcoin is up roughly 48% in seven weeks, for example, while Tesla has recouped nearly all of its 2022 losses with a 70% rally in the same stretch.
Different from 2021, however, is that institutional and retail investors look like they're on the same team, at least to a noticeable degree.
In the last quarter of 2022, filings show Bridgewater nearly tripled its GameStop and AMC holdings, while Steven Cohen's Point72 hedge fund also bet on GameStop and built a $108 million stake in Tesla. Billionaire George Soros, meanwhile, took sizable positions in Rivian and Peloton.
New this year, too, is the AI hype-trade, which mirrors the FOMO trade of the meme stock days. Since OpenAI's language bot, ChatGPT, has gone viral, investors have clamored to capitalize on the buzzy tech, sending shares of everything from chip makers to obscure tech names skyward in a gold rush for anything even vaguely related to the nascent space.
The Fed won't rescue stocks
Ultimately, good news is still bad news for stocks. Jobs data, consumer spending, and inflation all tell us the Fed isn't done raising rates. To JPMorgan's Kolanovic, retail investors' optimism foreshadows future weakness in the stock market, as weak hands get wiped out by volatility, similar to how 2022 played out.
With the Fed still set to tighten monetary policy, retail investors' enthusiasm for risky assets could backfire like it did last year. A recession is still a real possibility, and being overly invested in speculative bets is a sure way to feel the bite of a downturn and lead to another hibernation period.
"The bear market rally that began in October from reasonable prices and low expectations has morphed into a speculative frenzy based on a Fed pause/pivot that isn't coming," said Mike Wilson, the CIO and chief US equity strategist at Morgan Stanley.
He sees US stocks falling more than 20% in the coming months, citing a torrid start-of-2023 rally that's run too hot.
Of course, the grand irony is that the triumphant return of day traders has caused the very overextension that's put stocks is such a precarious spot.