Retail investors' appetite for US stocks faces a significant test as the record-breaking buying spree that fueled last month's rally shows signs of exhaustion.
Data from Castle Securities indicates that January's net inflows were more than 50% higher than the same period last year. Scott Rubner, the firm's Head of Equity and Equity Derivative Strategy, stated that retail buying on this scale is difficult to sustain—especially in February, a seasonally weaker month for stock purchases.
Castle Securities' data shows that since 2017, retail activity has consistently cooled as the market transitions from January into February. Following the initial surge at the start of the year, net nominal fund flows tend to decline.
The long-awaited rotation of funds from large-cap tech winners to other sectors of the market—a hallmark feature of recent months—appears to have lost momentum recently. Although the Russell 2000 Index outperformed the S&P 500 by 3.9% in January—a result seen only six times in the past five years—this relative strength peaked on January 22nd and has since begun to narrow. As earnings season approaches, investors are once again buying into large-cap technology stocks.
Rubner noted that, historically, small-cap stocks often enter a consolidation phase in the two months following such periods of outperformance.
This is significant because the small-cap index has greater exposure to high-beta themes favored by retail investors, such as drones, robotics, nuclear power, and space—precisely the sectors that led the gains in January. Rubner suggested that as many of January's leading themes have become overextended and increasingly crowded trades, retail traders may begin selling these stocks to lock in profits as they adjust their positions.
In a report to clients on Tuesday, Rubner wrote, "Recent price action suggests this risk is becoming more relevant. The market's renewed rotation into large-cap growth and defensive sectors often coincides with pressure on retail-driven themes, highlighting their vulnerability to a slowdown in incremental buying."
Seasonal factors present another challenge for the US stock market. Data from Castle Securities shows that since 1928, February has typically been the second-weakest month of the year, with the S&P 500 falling an average of 9 basis points.
Rubner also pointed out that institutional client behavior reflects a shift in sentiment: hedging activity has increased compared to the start of the year.
Comments