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Markets are near all-time highs, but hedge funds are shorting stocks. Is retail too bullish?
KEY TAKEAWAYS
- The Shoeshine Boy Indicator – When everyday people get too deep into stocks, some believe it signals a market top.
- Odd-Lot Theory – Historically, small investors were considered “uninformed,” and smart traders bet against them.
- Retail’s Rise – Today, retail traders have access to the same data as institutions, thanks to the internet and social media.
- Institutional vs. Retail Flows – Hedge funds are increasing short positions while ETF inflows (a retail-heavy instrument) remain strong.
- Sentiment vs. Reality – High bearish sentiment doesn’t always translate to market downturns—2023 was a perfect example.
MY HOT TAKES
- Retail isn’t dumb anymore – The information gap has shrunk dramatically, so dismissing retail as “dumb money” is outdated—and possibly dangerous.
- Hedge funds aren’t always right – They move a lot of volume, but history has shown they can be very, very wrong.
- Retail-driven social media can move markets – Retail traders can create massive shifts, as seen with GameStop and meme stocks.
- Sentiment is a lagging indicator – Just because investors feel bearish doesn’t mean the market will drop.
- Stick to your strategy – Timing the market based on sentiment or hedge fund moves is a losing game.
A sentimental journey. There is a famous story on Wall Street about Joe Kennedy Sr.—as in JFK’s dad and prolific investor. He was getting his shoes shined in the late 1920s, and his shoeshine boy, while doing his bit, started to give Kennedy stock tips. As the story goes, Kennedy returned to his office and promptly sold all his positions saying, “if even shoeshine boys are giving stock tips, then it’s time to get out of the market.” Soon after came the 1929 stock market crash and Kennedy survived due to his foresight… and those stock tips. Side note: you may have heard a similar story involving J. P. Morgan, but it was in fact Kennedy ( J. P. Morgan died before the 1929 stock market crash 😉). Ok, moral of the story is that when “dumb” investors get in, it’s time for the “smart” investors to get out. Don’t get insulted by the word “dumb,” it is just a proxy word for “Wall Street Insiders,” a misnomer in and of itself, because anything “insider” on Wall Street is actually illegal.
The idea behind all this is that Wall Street money knows more than the lowly shoeshine boy, so by the time any important information would filter down to the small “guy,” it would be old news and time to move on. There is another similar, but more well-founded axiom called the “Odd-Lot Theory,” (OLT) which also came from the early part of the 20th century. Back in the old days of the stock exchange, shares were traded in Round Lots which were blocks of 100 shares. In fact, the iconic consolidated tape would only list round lots. For example, a tape entry of “IBM 150 ½ 8” meant that IBM traded 800 shares at $100.50. The idea with OLT is that only institutional traders would be able to afford to trade round lots, and those institutional traders, being in the know, would have better insight into the companies being traded. This assumption implies that odd lotters make bad investment decisions based on lack of information. This is probably where the “dumb” moniker emerged. The idea, a contrarian one, was to trade opposite of the dumb, shoeshine boy, odd lotter in order to reap great rewards.
Bringing things into the 21st century where “dumb” is not necessarily politically correct—in some circles (🤣), those investors have been assigned a new description: “retail.” A retail investor is simply anyone who is not an institutional investor. These days, there is no real consolidated tape where odd-lots are traded off-tape by exchange specialists. No. Today, we know everything! Every tick, every trade… technically. I say “technically,” because some firms offer clients the ability to trade in fractional shares, that is less than 1 share. In those cases, the firm is the counterparty to the trade with the client, taking on the principal risk of the trade, but ultimately, all exchange trades still occur in single shares. That said, pretty much every investor, including the shoeshine boy, knows what is happening in the market.
Going beyond that, information has become highly democratized with countless news outlets providing financial news around the clock from around the world. Back in J. P. Morgan’s and Joe Kennedy’s day, information was closely held by the big players. The information was distributed by brokers to their clients long after the institutions already reacted to it. If you didn’t have a good broker, you would have to read about it in the newspaper. Imagine how many trades occurred before information reached the average retail investor. In fact, even when I was still a Wall Street neophyte, the average investor was still reliant on broker recommendations and the Wall Street Journal to find out what was going on. One could get a leg up by reading the pinkish Financial Times (the paper actually appears pink, if you’ve never seen it), which would show up on your stoop before the journal, but it was still not unlike the 1920s. When I started on Wall Street, only the elite had access to things like a Bloomberg terminal or a Quotron (or Telerate, if you were a bond person) with the Dow Jones News Feed (also referred to as a tape, these days).
Clearly, the internet changed all that! As aforementioned, anyone can get news almost instantly, and on par with the “smart” investor set. In fact, most of us Wall Streeters even watch social media outlets like Twitter / X to possibly get a jump on any financial news. There are countless video streaming services that provide almost round the clock financial news and expert analysis in real time. So, from an information perspective, it is fair to say that there are no real “smart” or “dumb” investors. But to be fair, getting the right information in a timely manner is just the first part of the success equation. Obviously, the ability to interpret and act on that information is a whole other thing. I would like to believe that my 35 years in finance have taught me a thing or two about WHAT NOT TO DO. Even so, average retail investors are not so dumb.
Why am I going through all this? Well, there are many folks out there who like to follow what the so-called "smart” money hedge funds are doing and mimic them. All institutional investors must disclose their holdings in a Form 13F filing, quarterly. These are also used to get a temperature reading from the “smart” set. I recently read a story that talked about how hedge funds were becoming increasingly short in the equity markets—the equivalent to becoming bearish. It seems reasonable given that markets are trading near all-time highs, stock valuations are super-rich, and there is a rapidly expanding fog of policy uncertainty enveloping the markets. Despite this, funds invested in non-money market ETFs are at all-time highs, after a surge last year. The flow rate did slow in January, which is notable. ETFs are considered a more retail oriented instrument.
So, what gives. Are dumb, retail, odd-lotters right, or are the smart-money, Patagonia-vest-wearing finance bros onto something? Who should we listen to? And why are retail investors so bullish? Let’s start with the second question. It is possible that retail investors are unwaveringly bullish based on their recent experience during the pandemic in which economic conditions were bad in an unprecedented way, but despite this, stock market returns were extraordinary, and but for 2022, stock returns outperformed experts’ expectations in the years following.
Regarding the question on which type of investor we should listen to, we need to think about the dynamics of the markets. While it is true that institutions throw around a lot of stock (70% to 80% of daily volume) which could push markets one way or another, we cannot discount retail investors. I need only point to GameStop and how an army of retail investors quite literally put some sizable “smart” investors on the beach. That means out of business. So, I would say that the answer is that we need to pay close attention to not just the Joe Kennedy’s of the world, but also the modern-day shoeshine boys who trade stocks on their smart phones. I will leave you with this. The American Association of Individual Investors (AAII) polls its members weekly on their sentiment, and the latest reading showed that 47.3% of respondents were bearish. This represented the highest reading since 2023. So, should we heed? I plotted (see below) the index back to 2023 and was surprised to see that the bearish sentiment was quite high throughout 2023—a year in which the S&P500 gained 24.23%. It would therefore seem that this is all descriptive rather than prescriptive. Stick to your strategy—that is what will truly determine if you are a smart investor, despite the size of your portfolio.
FRIDAY’S MARKETS
Stocks had a mixed close on Friday amidst uncertainty about—just about everything from tariffs to economic health to what the Fed might do next. Retail Sales came in quite a bit lower than economists were expecting, which could portend a better outlook for inflation, however, it’s not retail goods consumption powering inflation but rather services inflation, not necessarily driven by consumption 😉.
NEXT UP
- Empire Manufacturing (February) may have improved to -2.0 from -12.6.
- NAHB Housing Market Index (February) probably slipped to 46 from 47.
- Later this week: plenty of earnings on deck along with housing numbers, regional Fed reports, FOMC Minutes, flash PMIs, and University of Michigan Sentiment. Download the attached economics and earnings calendar to ensure that you are the bird that gets the worm. While you are downloading, don’t forget my daily chartbook, which is filled with the most important charts to start your day—every day.
- Fed speakers today: Mary Daly and Michael Barr.
- Notable earnings today: Vulcan Materials, Chemours, Sandisk, Northpoint Bancshares, Entergy, Devon Energy, Celanese, Toll Brothers, Occidental Petroleum, EQT Corp, CoStar Group, Compass, and Arista Networks.
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