Reality Bites, and Its Teeth Could Drag the Market Lower

|June 15, 2020

Just when the markets looked so promising to so many people, reality bites.

Yes, I’m talking about the frightening second wave of coronavirus infection spikes hitting U.S. states that recently “reopened”, hitting several countries especially hard, and as of this weekend, hitting Beijing, China, causing lockdowns in the country’s capitol.

That’s freaking out investors.

But, that’s not what’s got the potential to crash the market.

It’s the irrational exuberance of retail “investors” who’ve driven stocks higher, who could start freaking out themselves, start dumping positions, and stop being the market’s rocket fuel, that could tank markets.

I’ll give you the big picture and the sordid details on all that in your next Total Wealth.

But suffice it to say the millions of new retail accounts opened up since the pandemic started, Schwab alone opened 609,000 new accounts in the first quarter of 2020 and another 1.25 million in May, with their no-commission trading accounts and the ability to buy fractional shares, makes the “day-trading” phenomenon of the late 1990s look tame.

And we know what happened then.

If you don’t remember, those day-traders, retail investors who thought they’d become stock trading professionals simply by trading hot momentum-driven stocks, who helped pump-up those stocks until the tech wreck took the Nasdaq Composite down 85.6% and killed the day-trading craze and some investors, is what retail investors today look to be emulating.

Professionals have been chasing the FOMO (fear of missing out) retail crowd, not the other way around.

And while there’s a ton of institutional money on the sidelines, maybe as much as $1.5 trillion that missed the rally and could cushion any market sell down, the fact that we may not have made it over to the other side of the pandemic’s worst effects and all those stocks bid up by new retail money could have been bid up into overvalued-by-a-lot territory, could cause retail panic selling, and worse.

Every time there’s some good news on the pandemic and states reopening retail investors chase up beaten-down stocks like the airlines, the cruise lines, like banks, and cyclicals, sending them up double-digits in a day. And every time the market drops, they dump those same stocks, often sending their shares down 5%, 10%, 15%, 20%, or more.

Retail investors sold on Thursday. And they bought back stocks on Friday.

The question now is, will they freak out if they start losing money, if they were wrong about the worst of the pandemic being behind us, if the market they drove higher falls in their faces?

We’re about to find out.

The Dow fell 6.9% on Thursday last week. That’s scary. For the week it was down 5.55%. That’s a big hit.

The S&P 500 lost 4.78% last week and the Nasdaq Composite lost 2.3%.

It was a bad week, but nothing compared to what the Russell 2000 did. The Russell declined 7.6% on Thursday. Its three-day decline tanked the broad domestic market index 11.8%. That’s a correction.

If retail doesn’t step up and buy these next few “dips” and if institutional money laughs off the reversal and expects heavy selling to bring overvalued markets back down to where they think they should be, we’re in for a rough ride.

You’ve been warned.

Until then,