In a research note published over the weekend, JP Morgan analyst Nikolaos Panigirtzoglou issued a dire warning about the state of equity markets. According to Panigirtzoglou, equity volatility has scared away retail investors, which means that markets are now much more susceptible to a downside correction.
Only last week, Panigirtzoglou and team publish a note in which they claimed that retail investors were flooding back into the market as the marginal buyer of equities, which they believed was “important for the bullish thesis, as it will take some time until momentum improves and vol normalizes inducing institutional investors including CTAs and other trend following investors to start building up long equity positions again.”
The analysts opined that investors following the “buying the dip” mentality were supporting markets as other major players slowly re-entered.
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It now looks as if this thesis has been debunked. According to the latest report, the “erratic behaviour of retail investors this past week and the spreading of equity ETF outflows out to non-US equities casts doubt on the idea that retail investors will serve as the marginal buyer of equities in the current conjuncture.”
The lack of retail investor support is bad news for several reasons according to JP Morgan’s team. First of all, institutional investors currently appear to be unwilling to become the marginal buyer of equities “against a backdrop of elevated volatility, low market liquidity and disappointing economic releases.” And secondly, the other significant incremental buyer of equities that is expected to support the market this year, share buybacks, “might take some time to materialize.”
Indeed, thanks to record levels of corporate cash as well as the Trump tax cuts, corporations are expected to unveil a record level of share buybacks of this year to reward investors. Wall Street analysts have been trying to outdo each other in estimating how much cash will ultimately be returned with Goldman estimating that buybacks could jump 20% this year to hit $650 billion, while JP Morgan’s equity analysts believe a whopping $842 billion, or $70 billion a month could be distributed.
To put this figure into some perspective, according to the Federal Reserve’s flow of funds data, since the financial crisis (2009) non-financial corporates have spent an estimated $3.3 trillion buying back stock, compared to acquisitions of $1.6 trillion buy mutual funds and ETFs, and sales of $672 billion for households. Institutions have sold a total of $1.2 trillion over the same period.
With this being the case, it’s no surprise Panigirtzoglou believes corporations are going to be the primary big incremental buyer of equities this year.
However, with retail investors stepping back corporations need to step in to fill the void left over as soon as possible. If not, and equity markets go on to breach the lows seen on February 8 it “raises the risk of capitulation and thus of a more serious correction beyond the 10% decline seen between January 26th and February 8th.”
“The potential withdrawal of retail investors as the marginal buyer of equities could create clear downside risk for equity markets for the near term – especially after buying an unprecedented $100bn of equity ETFs in only one month during January. This is not only because institutional investors appear to be unwilling to become the marginal buyer in a backdrop of elevated volatility, a deterioration in market liquidity (see section below) and signs of the strong growth momentum over the past 6 months having peaked given recent disappointing economic releases. But also because the other big incremental buyer of equities we envisage for this year, i.e. share buybacks, might take some time to materialize.”
