I am not going to profess to know exactly how retail brokerages make money, but I am pretty sure profits are highly correlated to customer growth and trading activity.
Given the below charts, I think it is safe to say that retail traders have been very active, with most major brokerages exhibiting strong up-trends since 2012.
What does this mean? Retail is typically wrong; buying tops and selling bottoms. This doesn’t mean that we are necessarily at or near a market top right now, or that there isn’t more upside. But given the very well established tendencies of the average retail trader (and many many other factors), I think it is safe to say that the current cycle is closer to a top than bottom.
The charts on IBKR, AMTD, ETFC, and SCHW are actually quite constructive, having broken out of multi-year bases. Technically, they are likely good candidates to be bought on consolidations or pullbacks.
However in terms of market implications I would consider brokerages stocks as a lagging indicator rather than leading. Lets just say that last week was some sort of top; most retail traders will continue to buy dips (and generate brokerage profits) until we have some sort of significant correction. And why wouldn’t they? Buying SPY on every major dip since 2009 has worked: notably every pullback since 2011 has been smaller than the last, and 2013 has particularly reinforced the mentality. Not surprisingly, #BTFD (buy the fucking dip) often trends on Twitter whereas you’ll have a tough time finding #STFR (sell the fucking rip) tags.
Brokerage stocks will likely continue to gain until a big enough correction is experienced that is significant enough to spook the average retail investor. It wasn’t until a full year after the 2011 correction (in which there was enough volatility to sideline most retail traders) that most brokerages bottomed and broke out of multi-year bases.
Eventually it will end bad. Hot trending stocks like BBRY and TSLA will continue to burn BTFD “stock gurus” and their retail followers. What was previously deemed as stock picking skill will eventually be determined to be nothing more than excessive risk taking (read Nassim Taleb “Fooled By Randomness”) by many.
What is the takeaway on this? The time for excessive risk taking is long past. BTFD may continue to work for sometime, but eventually it won’t and many will find themselves with years of gains wiped out in a short period of time.
The strength in retail stocks confirms that retail investors are active participants in the complacent rally that began in 2012, and retail investors historically have poor timing.
- Brennan Basnicki