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Sunday, September 13, 2020
The Transformation of the U.S. Financial Ecology in the Context of Excess Capital
ANBOUND

The U.S. stock market has long been dominated by institutional investors, with retail investors accounting for only about 10% of the trading volume. In mid-2018, U.S. institutional investors accounted for a whopping 93.2% of the market capitalization, while retail investors accounted for less than 6%. The latest data shows that the retail trading boom is reshaping the U.S. stock market in the wake of the Covid-19 outbreak. Retail stock trading in the United States is at its highest level in a decade. In the U.S. stock market, which has traditionally been dominated by institutional investors, the trend of retail investors picking up is becoming a new phenomenon with structural implications for U.S. capital markets.

In the face of the pandemic, the stay-at-home young American generation has started trading in the stock market. In addition, the zero-commission model of online brokerages has attracted a large number of retail investors in the U.S., who have become increasingly active as the U.S. stock market continues to hit record highs. Robinhood Market Inc.'s exposure in financial news and stock forums has skyrocketed recently. Robinhood is the favorite zero-commission trading platform for U.S. millennials, where users can trade stocks, ETFs, options, etc. The platform now has more than 10 million accounts, mostly owned by retail investors, with an average age of 31. In the first four months of this year, Robinhood saw a 30% increase in users.

Robinhood, the emerging retail brokerage that bills itself as the "retail stronghold" in the U.S., added 3 million trading accounts in the first quarter of this year, bringing its total number of accounts to 13 million. Recent data shows that Robinhood hosted more than 4.3 million daily average trades in June and its daily average trades more than doubled in the second quarter from the previous three months. According to a recent regulatory filing with the U.S. Securities and Exchange Commission (SEC), Robinhood generated USD 180 million in order flow revenue in the second quarter, of which USD 111 million came from options trading, roughly doubling revenue from the previous quarter. The other three major U.S. retail traders, TD Ameritrade, Charles Schwab, and E-Trade, have all seen record growth in their trading accounts in 2020.

It is worth noting that retail investors in the past are driving big moves in some stocks, creating the so-called "Robinhood effect" -- investors using popular apps stampeding in and driving irrational price movements in stocks. Larry Tabb, Head of Market Structure Research at Bloomberg Intelligence, said recently that retail trading accounts for a greater share of market activity than at any time in the past decade. In the first six months of this year, retail investors accounted for 19.5% of U.S. stock market trading volume, up from 14.9% last year and nearly double the 2010 level, Tabb estimates. On some days this year, retail activity even accounts for about 25% of market transactions. The data suggest that retail traders are upending years of trading patterns in the U.S. stock market.

To what extent will the large number of retail investors entering the market affect the trading structure of U.S. stocks? Will this be a confirmed and sustained trend, or just an occasional blip?

Traditional institutional investors are not optimistic about retail investors entering the market, believing that retail investors are a kind of crazy people who do not understand market risks. As hedge fund magnate and founder of Omega Advisors, Leon Cooperman, says the frenzied trading in certain stocks in recent months is a warning sign for the market. He sees this as a sign that the market is close to its peak and that the surge in daily transactions for apps such as Robinhood is a "crazy market". Cooperman warns that speculative trading by retail investors would not end well, "They are just doing stupid things, and in my opinion, this will end in tears." The stock market is so crazy that even professional investors fear it. "With a market like this, who needs to go to Las Vegas and Macau?" said a 20-year veteran trader in Germany.

However, researchers at ANBOUND believe that institutional investors' dismissive attitude to new developments in the U.S. stock market may be too conceited. Institutional investors once dominated trading in the U.S. stock market, and the "rules of the game" in the market were set up for them -- the market trusts them and hands them money (in various funds); institutional investors establish an investment team to evaluate the investment value and risk; institutional investors determine investment strategies and portfolios and make investment transactions; the institution determines their principle of returns, such as the proportion of capital management fees; regulatory rules were also set up for institutional investors. However, institutional investors have been disrupted by an influx of retail investors who are not following the rules of the game at all and are trading irrationally. So, it is entirely understandable that retail investors provoke the "wrath" of institutional investors.

In our view, this is a significant shift that may be related to the changing context of the current financial markets. Unlike the past, when there was a shortage of capital, today's world is a world with excessive capital. Historically, since the collapse of the Bretton Woods system, the "floodgates" of central banks' credit expansion have been removed, and the world has gradually moved towards a credit expansion trajectory. Since 2008, in particular, the continued massive easing by the world's major central banks has exacerbated the extent of the world's capital glut. The "crisis triangle" model proposed by ANBOUND explains the origin of excess capital from the perspective of credit expansion; with excessive urbanization brings about capital expansion, while capital expansion brings about crises.

When these changes accumulate to a certain extent, financial ecology begins to change. We tend to believe that this is not an accidental fluctuation, but a major change or shift involving the development of financial markets. From the perspective of Modern Monetary Theory (MMT), widespread excessive capital is not an accident. In the view of MMT, money originates from the debt-liability relationship, governments spend money by creating money, and fiscal expenditure precedes revenue. MMT argues that sovereign governments do not go bankrupt under a sovereign monetary system, and that issuing bonds is similar to monetary policy, sovereign governments do not need to borrow in their own currency to spend. The corollary is that government spending is not constrained by the country's tax revenue, i.e., there is virtually no constraint on fiscal expenditure. With the current outbreak hitting the global economy, MMT is undoubtedly a gateway for governments in need of fiscal expansion to stimulate their economies -- a tempting policy of debt expansion for governments not to worry about local-currency debt leading to government bankruptcy.

While MMT remains highly controversial in academic circles and policy departments, the practice of countries under the pandemic shows that major countries have adopted fiscal expansionary policies to varying degrees. Especially the United States, where the federal deficit could reach USD 3.4 trillion in FY2020, and the balance of government debt will soon exceed the size of the annual GDP. This means that the world will be in the midst of an ever-growing glut of capital for a period and even an era to come. As the environment changes, the trend of retail participation in the U.S. stock market is likely to continue, which will change the trading structure of the U.S. stock market and even the financial ecology of the United States.

Final analysis conclusion:

As a result of the pandemic, a large number of retail investors participating in the stock market is becoming a trend, which could change the pattern of the U.S. stock market. In the context of excess capital, this change is not an accidental market fluctuation and is likely to imply a structural change in the financial ecology of the United States.

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