Typically, stock market rallies out of oversold conditions during a period of economic crisis is dominated by institutions, long-term, value investors, and savvy traders. That's why this market action is so unique.
The current market is dominated by retail traders. Of course, it's in part due to the stimulus checks, stay-at-home orders, and shutdown of so many outlets for entertainment. Additionally, many gamblers without live sports, seem to have found an outlet in the stock market, as well. Even before the coronavirus, "buy the dip" had become the market meme due to the bull market's decade-long run in which this attitude had been amply rewarded. And, that strategy continues to work.
Robinhood Factor
There's also the Robinhood factor which has brought Millennials into the market and turned it into a video game for many people. However, Robinhood has actually had seismic impacts for the brokerage industry in terms of forcing everyone to embrace zero commissions for stock trades.
The combination of all these factors has led to an explosion in the number of new accounts for all brokerages. In the last quarter, TD Ameritrade (NYSE: TD) reported 661,000 new accounts opened, E-Trade (NYSE: ETFC) reported 329,000 new accounts, and Schwab (NYSE: SCHW) added 552,000 new accounts as well. All of these brokerages reported new records in terms of trading activity.
Underperformance
It would seem that an increase in new accounts and increasing trading activity would lead to an increase in the stock price for these companies, but this isn't the case due to falling commissions and low-interest rates. Both have historically been the major sources of profits for brokerages. Low-interest rates meant that brokerages could earn some sort of return on cash in customers' balances by parking that money into safe, risk-free securities. However, those don't really currently exist due to the Federal Reserve implementing zero-interest rates.
This is apparent in the company's stock prices as well which haven't benefitted from the bull market nor the trading boom. Schwab is up 20% from its lows, and TD Ameritrade is 33% higher. Both are underperforming the S&P 500's (NYSE: SPY) 42% gain.
Looking Forward
Despite these short-term challenges, the brokerage stocks offer an intriguing upside. Public interest in the markets has increased. People are using their products. Interest rates have basically bottomed, and commissions can't go any lower.
The negatives are already priced into these stocks. However, the brokerages have several opportunities to innovate and develop, new revenue streams like selling asset management, research, premium services, or other, adjacent financial products. And if brokerages aren't able to capitalize on the opportunity, they will be tempting targets for larger banks who would want to get more customers and assets into their ecosystem.
The low-rate environment is brutal for banks for a variety of reasons, but larger banks see it as an opportunity to grow and win market share from smaller banks. It's why so many banks are offering deposit bonuses for new accounts. The same logic will apply to brokerages. Additionally, downside is limited, because two of the worst outcomes for brokerages - no commission and zero percent interest rates - are already priced in.