The investor warning signs ASIC is watching

By Tony Kaye, Senior Personal Finance Writer, Vanguard Australia

Amidst the COVID-19 pandemic there’s been a surge in day-trading activity by retail investors chasing quick wins.

Australian share market data shows daily retail turnover is around double what it would normally be, fuelled by a record number of investors opening online share trading accounts for the first time and reactivations of dormant accounts.

Large amounts of retail investment capital is flowing into companies with speculative valuations that have never reported a profit, and into high-risk, leveraged exchange traded products.

Herd buying momentum, in some cases inspired by social media forums, has resulted in the share prices of some small companies doubling, tripling and even quadrupling in a short period of time.

They’re all disturbing trends that have been identified by the Australian Securities and Investments Commission (ASIC), and the national investments regulator is concerned on a number of levels.

ASIC has recently been contacting various Australian stockbroking firms and presenting its concerns.

We’re concerned with the source of funds (for example, the government stimulus and superannuation), investing motivations and behaviours, the risks with some products and the impact of price runs on the integrity of stock valuations,” ASIC noted in a recent broker presentation.

It’s also concerned about the increased use of leveraged products and whether there is enough consumer awareness around the risks they are undertaking.

Short-term trading surges

There has been a marked increase in trading activity and frequency among retail investors.

Between August last year and late February this year, the average number of days between trades of the same stock was 4.9. Between 24 February and 3 April this year, that had dropped to just one day.

Over the same period, the average number of days between trades of any stock fell from 2.54 to 0.9.

While ASIC said it’s positive that many first-time investors are accessing markets and have made gains, the regulator also points out there has been a propensity by retail investors to buy ahead of market declines and sell ahead of rebounds.

Retail investors are generally bad at market timing. It has moderated since March-April, but the trend continues,” ASIC said.

Over the period from 6 April to 12 June ASIC data shows retail investors who held for just one day recorded $74 million in combined net losses, even though the Australian share market increased by 16 per cent over the same time frame.

The chart below records net trading activity day by day between 24 February and 3 April, with heavy activity often followed by sharp losses on the following day.

As noted, ASIC also is mindful that heavy retail trading has caused many speculative stocks to experience extremely rapid run-ups in their share prices.

For stocks that more than doubled in price since early April (when the index rebounded 16 per cent), there has been a significantly higher concentration of retail trading than the broad market average. The vast majority of these stocks have negative earnings and speculative valuations,” ASIC said.

Despite strong momentum in the short term, significant run-ups, higher valuations and negative earnings mean greater risks over a longer horizon.”

Among the heaviest traded companies have been the so-called buy now, pay later stocks, and leveraged negatively correlated exchange traded products that enable investors to benefit from a declining share market.

Between 6 April and 12 June, the share prices of 255 stocks on the Australian Securities Exchange doubled, 70 tripled and 29 quadrupled.

Around 80 per cent of the 255 stocks had negative earnings in the past financial year. The remaining 20 per cent had a high price-earnings (P/E) ratio (average around 55 times). In contrast, the All Ordinaries Index average P/E ratio was 19.

Retail investors represented over 80 per cent of trading in these stocks (versus 16 per cent across the broader market).

Key messages for retail investors

There are various factors that retail investors should heed, especially during the COVID-19 environment.

• Despite recent gains, the markets remain volatile. Don’t rely on past performance for future investments or invest more than you are willing to lose.
• Avoid trying to time the market – that is very hard to do and can lead to losses.
• Less liquid or risky shares may fall suddenly in price, and it there are less buyers when you want to sell you may not be able sell at a price you would like.
• The revenue of many companies has been significantly impacted during COVID-19. Past earnings may not be indicative of future earnings and a company’s P/E ratio may not be a reliable indicator.
• There has been an increase in companies raising capital by issuing new shares. The issues often occur at a discount to the recent share price and may dilute existing shareholders. If you get an offer booklet, consider the impact it will have on your investment.
• Focus on longer-term goals and don’t make rash decisions based on recent market falls or gains. Develop an investing plan and stick to it.
• Educate yourself on the operation and risks of any product before trading, especially where there is a risk of losing all of, or more than, your initial investment.
• Don’t rely on claims in advertisements and social media forums when making investment decisions. There are a lot of scams and misinformation about products and trading strategies.

If you need support around your investment decisions, it’s important to seek advice from a licensed financial adviser.