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In One Chart: Individual investors may be running out of ‘firepower’ after diverging from ‘smart money’ stock-market investors, says Morgan Stanley

Individual investors remained strong buyers of stocks in recent weeks, diverging from the path taken by many institutions, as they helped push the stock market to a new high, according to a Morgan Stanley report.

The S&P 500 index has been resilient this year, with individual investors scooping up stocks during the “September swoon,” said Lisa Shalett, chief investment officer at Morgan Stanley Wealth Management, in a note Monday. Institutional investors tracked by the “Smart Money Flow Index” didn’t share their “enthusiasm,” she said, citing a chart showing their divergence.


“The Smart Money Flow Index showed institutional investors reducing their risk exposure while individual investors increased theirs,” said Shalett. “If individual investors are leading, how much more firepower do they have?”

Retail investors have gained influence in the stock market during the pandemic, contributing about $1 billion of inflows a day so far this month, according to Morgan Stanley. Daily retail net inflows since March 2020 have on average tripled the roughly $360 million level seen during 2018 – 19, helping to propel the S&P 500 to a fresh peak this month, Shalett said.

Their “firepower” is being used to buy the dips, possibly due to “fear of missing out,” known as FOMO, or because ‘there is no alternative,’ often referred to as TINA, she said in the report. TINA holds that with deeply negative real interest rates, there is no alternative to equities.

Shalett said that “yet another theory suggests risks around supply-chain disruptions and inflation have been discounted and, with ample cash still on the sidelines, the odds tilt to the upside.” 

But the “cash on the sidelines” that individual investors have deployed to buy market dips “may be maxed out,” according to the Morgan Stanley note. When considering cash levels in relation to total assets and net worth, Shalett wrote that household cash is “now back at levels consistent with and even slightly below the average since 1989.”

Read: Stocks may fall 15% by year-end, warns Morgan Stanley. Here are some portfolio moves investors might consider.

The call that Morgan Stanley’s global investment committee made for a 10% to 15% correction this year in the S&P 500 has been wrong so far — “or at the least, premature,” said Shalett.

The S&P 500

fell almost 5% in September, but its climb higher this month has brought year-to-date gains to more than 21%, according to FactSet data. The index was up about 0.5% Monday afternoon, the data show, at last check.

“The broad index never fell more than 5% from its Aug. 30 high, and this past week registered a new all-time high of 4,450,” said Shalett. “Even so, there has been a rolling correction within the index as 88% of its constituents have experienced at least a 10% decline from their year-to-date highs.”

Meanwhile, individual investors’ ability to keep plowing “new money” into the stock market may be “nearly spent,” warned Shalett. She also pointed to an “impending squeeze on market liquidity from the confluence of Fed tapering, a new Treasury debt ceiling, higher energy prices and possibly higher taxes.”

Yet, the Dow Jones Industrial Average index

rose to an all-time closing high Friday, carving out an intraday record Monday along with the S&P 500.

See Monday’s Market Snapshot: Dow, S&P 500 carve out intraday records ahead of earnings from Facebook, others

Also see: JPMorgan portfolio manager adds S&P 500 exposure. Here’s why he’s bullish

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