Hello Kitty

.

  By Guest Blogger Doug Rowat

.

On May 12, Keith Gill, aka Roaring Kitty, posted a pic of a man leaning forward in his chair. That was it. GameStop shares soared 74% the next day.

Never mind that there was no takeover announcement, zero change in the company’s fundamentals and no broader change in the video game industry, retail investors were satisfied enough by the pic alone to bid the stock up to the moon. They also apparently ignored the fact that no one on planet Earth could have anticipated this share-price ‘catalyst’ save for Roaring Kitty himself.

This sketch led to a 1-day 74% jump in GameStop shares

Source: X (Twitter)

It should come as no surprise that GameStop shares are now down 20% from their May 13 closing price.

No doubt a few lucky retail investors made a profit, but collectively, they got burned. But being on the losing end of a trade is nothing new for retail investors.

Despite their confidence, retail investors simply don’t have the time or energy to dedicate themselves to the research required to be successful. They’re firemen, teachers, IT specialists, bricklayers, pilots, bartenders, cooks, construction workers, engineers, lawyers, social workers. Noble professions across the board but also time-consuming ones. Their jobs have also likely never focused their education and training toward finance, market analysis or portfolio construction.

Their inexperience further translates into the wrong temperament for investing. Retail investors are overconfident when markets are strong and fearful when markets are weak. In other words, they make emotional investment decisions. Always the worst kind.

We already know through financial-services-industry-researcher Dalbar that average equity investors have badly underperformed the broader equity market over the long term. Just a few months ago, for instance, Dalbar released its latest 2024 Quantitative Analysis of Investor Behavior report. It doesn’t paint a pretty picture:

Growth of US$100,000 – 30 years

Source: Dalbar. Growth measured from January 1, 1994 to December 31, 2023

Last year was more of the same: the average equity investor earned 5.5% less than the S&P 500 in 2023.

However, now an even more a disturbing trend is emerging. Retail-investor involvement in the market is expanding dramatically. According to Amundi Asset Management, retail trading accounted for less than 10% of US stock-market trading volume in 2010. Now it accounts for more than 18%. Blame the rise of smartphones, social media and mobile-trading apps for this expanding retail presence. Many of these mobile-trading apps now even offer 24-hour trading—just what every impulsive and inexperienced retail investor needs.

Sadly, of course, the flood of social media information combined with at-your-fingertips trading execution has led, predictably, to an increase in risk taking. Amundi highlights some of the destructive impact:

Based on retail trading at two large German banks and] observing the platform used for each trade (e.g. personal computer versus smartphone), it was established that using the app, increased the probability of investing in risky assets (volatile or lottery-type stocks) by 67% in relative terms compared to non-smartphone trades. Smartphone trading also increased the relative probability of “chasing” returns (i.e. buying assets which rank in the top 10% in terms of past performance) by 71%.

In another study of Chinese retail-investor app-traders], young investors, who are presumably more prone to self-control problems, showed a greater increase in logins and trading intensity.

This research, of course, dovetails perfectly with all the young retail investors who, no doubt, frantically hammered away at their smartphones after Roaring Kitty posted his pic and GameStop shares soared.

So, we already know that retail investors are bad investors. But given the enormous increase in social media–fuelled advice combined with new trading apps that easily convert this dubious information into impetuous and poorly thought-out trades, my bet is that retail-investor underperformance will get even worse in the coming years.

The next wave of wannabe roaring kitties is going to be turned into roadkill. Avert your eyes.

Doug Rowat, FCSI® is Portfolio Manager with Turner Investments and Senior Investment Advisor, Private Client Group, Raymond James Ltd.