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The Reddit-fueled trading craze could signal permanent changes to the stock market, RBC says

Feb 2, 2021, 23:17 IST
Business Insider
Spencer Platt/Getty Images
  • Retail investors are likely to stick around and continue targeting names after the GameStop phenomenon, RBC strategists said Tuesday.
  • The crowd of day traders could aid active-management and deep-value investing strategies, the team said.
  • The trend spotlights extreme risk-taking and is similar to activity seen before the housing market crashed in 2008, RBC added.
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Retail investors' disruption to the status quo could be here to stay, according to strategists at RBC Capital Markets.

GameStop, AMC, and other recently unloved stocks spiked higher this month as traders uniting on forums such as the Wall Street Bets subreddit flocked to the names. Day-traders bid up companies with massive short interest and cheered as hedge funds exited their bearish bets with massive losses.

Wall Street was largely unprepared for the influx of retail-trader activity, but RBC's team suggests the establishment should get used to the day-trader crowd. Zero-commission trading, lockdowns, stimulus checks, and colder temperatures all contributed to the phenomenon, the strategists said. Structural changes to how the market operates could come as retail traders target one name after another, they added.

"Unless the door closes, we fail to see why retail investor interest in trading specific names will completely go away given how elevated cash on the sidelines is among consumers," the team led by Lori Calvasina said in a Tuesday note to clients.

Read more: The GameStop mania driven by Reddit traders isn't simple market trolling. It's a populist movement threatening to disrupt the financial system to a degree Occupy Wall Street only dreamed of.

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While some short-sellers will likely denounce the new trend, the advent of new retail-trader activity could aid active managers. Such managers lagged behind passive and quantitative strategies in recent years as the market broadly swung higher. Increased activity from speculative day traders could yield more market dislocations and give active strategies a new lease on life, RBC said.

Retail investors' trades over the past year also resemble the deep-value strategies that have largely been discarded by institutional investors. Prior to the GameStop frenzy, the group piled into recovery plays like airline stocks and cruise lines. The short-squeeze playbook currently dominating Wall Street Bets and other groups is only the latest iteration of their interest in value positions, the strategists said.

RBC expects the S&P 500 to reach 4,100 by the end of the year, implying a nearly 9% leap from Monday's close. While retail investors have driven new frothiness in the market, they seem "highly bullish" and should help drive the broader market higher, the firm said.

Investors should still regard the risk-taking on Reddit and Robinhood with some caution, they added. The activity is similar to that seen before the dot-com and housing-market bubbles, and should be monitored in case such a marketwide risk emerges.

"Canaries often sing early," RBC said. "These turned out to be warning signs, but didn't foretell an imminent peak in stocks. Intervention by regulators in particular could help contain the risk."

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Read more: This macro strategist's new retail-investor tracker nailed silver and AMC as likely targets for the Reddit-driven short-squeeze. These are the 4 stocks it says could be the next GameStop.

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