Equity Strategy Have retail flows gone too far?

Leverage data suggest little sign of excess yet. Margin balance as a share of market cap is in line with post-2015 average. Retail turnover & net flows show individual investors played a major role in the market in rest of Asia recently.

09 Jul 2020

Margin account balance as % of market cap for China A-shares

Source: Wind, Datastream, UBS

The line graph shows margin account balance as a percentage of market cap for China A-shares from 2010 to 2020.

The excitement in China hasn't led to overstretched leverage data yet

A sharp retail-driven stock market rally in China took many investors by surprise. The lingering concern is whether it will repeat the moves we saw in 2015. So far, leverage data suggests little sign of excess – yet. A key proxy - margin balance as a share of market cap – remains in line with the post-2015 average.

Retail flow data in the rest of the region does look stretched however

Both the spike in retail turnover (at their recent peak, retail flows more than doubled to 7% of market cap) and net flows (buying minus selling) show that individual investors have played a major role in the market in the rest of Asia recently. We only have net flow data for four markets, but these show similar trends - net retail flows for Korea and Malaysia had reached the highest level in our history during Q2 while Japan and Thailand flows were less extreme but still 1.5x standard deviations above their mean.

Elevated retail flow posts near-term risk of market corrections

Positive retail flows rarely persist from current levels. Our base case is that the flow is likely to weaken and revert back to its normal trading range. More concerning for the market is that past experience shows a negative correlation between net retail flow and the short term market performance – when retail flows have been this elevated in the past, market returns are generally negative on a 1, 3 and 6-month basis, regardless of valuation. Given how strong retail flow has been in Q2, this alone would suggest caution on returns in the second half of the year.

Implications of a return in foreign flows

Just as we expect retail flows to fade, we also expect foreign flow to gradually resume after recording one of the biggest sell-downs in March. Recent data is showing a gradual return, in line with past behavior following major sell-downs. If the marginal buyer shifts from retail to foreign investor, what might this mean? From a style perspective, our data shows that when retail flows have been strong, large cap, growth stocks with good price momentum have tended to outperform, while when foreign inflows predominate, there is much modest preference for value, price momentum hasn't worked so well, and large caps have tended to lag.

Authorized clients of UBS Investment Bank can log in to UBS Neo to read the full report.