Individual investors may run out of ‘firepower’ after diverging from ‘smart money’ stock market investors, Morgan Stanley says

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

Retail investors have gained leverage in the stock market during the pandemic, contributing about $1 billion in inflows so far this month, according to Morgan Stanley. Daily net inflows into retail sales since March 2020 have tripled on average from their roughly $360 million level in 2018-19, propelling the S&P 500 to a new peak this month, Shalett said.

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

Shalett said that “yet another theory suggests that risks around supply chain disruptions and inflation have been discounted and that, with plenty of cash still on the sidelines, the odds are tipping upward.”

But the “money on the sidelines” that individual investors have staked 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: Shares could fall 15% by the end of the year, Morgan Stanley warns. Here are some portfolio moves for investors to consider.

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

The S&P 500 SPX,
+0.47%
fell nearly 5% in September, but the rise this month has pushed annual profits to more than 21%, according to FactSet data. The index rose about 0.5% on Monday afternoon, the data shows, at its latest check.

“The broad index never fell more than 5% from its August 30 high, setting a new all-time high of 4,450 last week,” Shalett said. “Nevertheless, there has been a rolling correction within the index as 88% of its constituents have experienced at least 10% declines from their year-to-date highs.”

Meanwhile, individual investors’ ability to keep pumping “new money” into the stock market may be “near exhausted,” Shalett warned. She also pointed to an “imminent tightness in market liquidity from the confluence of Fed tapering, a new sovereign debt ceiling, higher energy prices and potentially higher taxes.”

But the Dow Jones Industrial Average Index DJIA,
+0.18%
rose to an all-time closing price on Friday and cut an intraday record alongside the S&P 500 on Monday.

See Monday’s market snapshot: Dow, S&P 500 set intraday records for profit from Facebook, others

Also see: Portfolio manager JPMorgan adds exposure to S&P 500. This is why he is bullish