Day Traders Sold Stocks at Record Pace During Inflation-Fueled Rally

(Bloomberg) — As US stocks surged to the best day in two years, one of the market’s most reliable group of buyers was nowhere to be found.

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Day traders dumped equities in droves, selling a net $2.65 billion in shares as the S&P 500 jumped more than 5%. The disposal was the most since JPMorgan Chase & Co. began tracking the flows five years ago based on public data on exchanges. The group also went bearish in the derivatives market via moves like buying put options, a tilt that prompted market makers to sell $1.6 billion of shares to avoid directional risk.

The exodus marked an about-face for retail traders who had been burned all year long trying to time the bear-market bottom. Missing out on the latest rally added to their pain. By JPMogan’s estimate, small-fry traders have seen 41% of their money wiped out since January — a loss that is more than double the S&P 500’s. For bulls, the latest failure was a sign that a key pillar of excess that had built during the easy-money post-pandemic era had finally been toppled.

“When it comes to retail capitulation, this data point should put any doubt to bed,” JPMorgan strategist Peng Cheng said in an interview.

Retail was bailing on stocks just as a cooler-than-expected inflation print touched off a rally for the ages. Institutional investors who had cut equity exposure to the bone or taken outright bearish positions on stocks likely drove the best advance since April 2020. Indeed, short sellers were among those forced to fold as the rally picked up steam during the day. A Goldman Sachs Group Inc. basket of the most-shorted stocks surged 11% Thursday.

History suggests small investors who missed the rally may not want to chase it now. Since 2006, the S&P 500 has scored 5% gains during 14 other sessions. Among them, nine saw negative returns one week later, with the index falling an average 2.6%, according to data compiled by Wells Fargo Securities LLC.

Thursday’s massive rally underscores the peril of investing during an entrenched drawdown like the one that’s gripped US equities all year. Sharp reversals have been the defining trait, with outsize reactions to readily shifting data and narratives. Driven by fears over a recession as the Federal Reserve embarked on the most aggressive inflation-fighting campaign in decades, professional money managers have spent all year cutting equity exposure and raising cash.

As much as that defensive posture is still in place, it could succumb to another rally should the S&P 500 move back above its average price for the past 200 days, according to Mike Wilson, chief US equity strategist at Morgan Stanley. The trendline, which put an end to the equity rebound during the summer, now sits near 4,080. The index added 0.3% to 3,968.20 as of 12:30 p.m. in New York.

A breakout at the 200-day average “probably gets the animal spirits going even more,” Wilson told Bloomberg TV. “And we could see an overshoot.”

In that case, the S&P 500 could have a shot at rising as high as 4,300, but Wilson says that would still be nothing more than another bear-market rally. Already, all rebounds of at least 5% from a near-term bottom have failed to hold.

While volatile times are supposedly when active investing shines, the price of getting even a few things wrong in a market as turbulent as this one can be costly. The penalty of bad timing can be illustrated by a statistic that highlights the potential harm an investor faces by sitting out the biggest single-day gains, moves such as Thursday’s. Without the best five, for instance, the S&P 500’s loss for this year widens to 31% from 17%.

“It’s going to remain volatile. This is not the kind of market that the average person should be trying to trade,” Wilson said. “It could be very profitable if you count it right, but you know, it’s still a bear market so it can rip you apart.”

–With assistance from Jonathan Ferro and Emily Graffeo.