Schwab Topping Goldman Sachs Presages Return to Stocks

Shares of discount brokers are gaining the most since 2003 compared with the Standard & Poor's 500 Index, a sign that small investors are joining the four-year bull market even after U.S. stocks suffered their biggest losses in six months.

Charles Schwab Corp. (SCHW), TD Ameritrade Holding Corp. (AMTD) and E*Trade Financial Corp. (ETFC) have climbed 38 percent on average in 2013, beating the S&P 500 by 23 percentage points and eclipsing returns in financial shares from Goldman Sachs Group Inc. to Bank of America Corp. (BAC), according to data compiled by Bloomberg. The last times that happened, equity mutual funds received about $91 billion, 24 percent more than the annual average in the two decades before the financial crisis, the data show.

Bulls say a rally in brokers that serve private investors means individuals are preparing to embrace shares after they pulled almost $400 billion from stock funds in the last four years. Bears say buying by individuals who missed the rally shows gains are close to peaking as another pool of untapped demand gets absorbed.

"It says something about an improvement of confidence among our biggest sector of the economy, retail investors and households," James Paulsen, the Minneapolis-based chief investment strategist at Wells Capital Management, which oversees more than $340 billion, said in a phone interview. "When the retail investor finally gets more confident about the future, flows follow."

Weekly Gain

The S&P 500 rose last week, snapping two consecutive losses, after American companies hired more employees than forecast in May. The gauge added 0.8 percent to 1,643.38, taking this year's increase to 15 percent and the advance since March 2009 to 143 percent. The S&P 500 fell 3.6 percent between May 21 and June 5, the steepest such decline since November, as investors speculated the Federal Reserve will reduce the bond purchases central to stimulating the economy.

Schwab, the San Francisco-based brokerage with 6.1 million retail accounts as of March 31, has climbed 40 percent in 2013, including a 24 percent rally since May 1 that is the fifth-biggest in the S&P 500, while Omaha, Nebraska-based TD Ameritrade is up 43 percent. By contrast, Goldman Sachs gained 30 percent in 2013 amid concerns regulations in the Dodd-Frank Act to curb risk-taking by financial institutions will reduce profits. Bank of America is up 15 percent and the KBW Bank Index (BKX) of 24 lenders' stocks rallied 20 percent this year.

Past Deposits

Firms such as Schwab offer cheaper trading services to clients who can't afford or don't need full-service brokerages, making them barometers of individual investor enthusiasm. The stocks beat the market by at least this much in 1997, 1999, 2003 and 2009, years in which the S&P 500 rallied an average of 14 percent from June 10 through December. Money sent to stock mutual funds during the last six months of 1997 totaled $108.5 billion and $91 billion in 2003, compared with about $12.3 billion so far in 2013, according to data compiled by Bloomberg and the Investment Company Institute.

The S&P 500 rallied 31 percent in 1997, its second-biggest advance since 1975, and 26 percent in 2003, the fifth-largest increase. This year's 15 percent gain is the best start to a year since 1998, data compiled by Bloomberg show.

"We have had a huge run-up in the stock market this year, and when you have the appearance of the economy getting better and the stock market improving you're going to get more people wanting to come in," said Jerome Dodson, president of San Francisco-based Parnassus Investments, which oversees about $7.3 billion, in a June 5 phone interview. "It tends to push the market higher." He owns Schwab shares.

$400 Billion

Investors pulled almost $400 billion from U.S. equity mutual funds from 2009 through 2012 while moving more than $1 trillion into bonds, as the worst financial crisis since the Great Depression bolstered the attraction of assets perceived to be the safest. The pace of deposits with fixed-income managers has slowed this year to $18.4 billion a month, the least since 2008, data from Washington- based ICI show.

Individuals are buying and selling more stock. TD Ameritrade's 417,000 average trades per day last month were 13 percent more than the year-earlier period, according to a June 6 release. At E*Trade, daily revenue-generating trades climbed 11 percent from May 2012, the company said at a conference on June 6. Schwab clients increased trading 3 percent in April, according to a May 14 release.

Earnings Estimates

While S&P 500 earnings are forecast to rise 6.6 percent this year and 11 percent in 2014, analysts are more bullish on Schwab. They predict profits at the broker will increase 10 percent in 2013 and 18 percent the next year, according to estimates compiled by Bloomberg. E*Trade, which has advanced 31 percent, is projected to return to profit this year and increase per-share earnings by 24 percent in 2014. The growth forecast for banks in the S&P 500 falls to 6.2 percent this year and 5.6 percent next year.

Concern that improving economies will give central banks leeway to reduce stimulus increased swings in American equities last week, sending the Chicago Board Options Exchange Volatility (VIX) Index up 21 percent in May. Japanese shares, which have been the best in the world the last seven months on speculation Prime Minister Shinzo Abe would end two decades of deflation, dropped 17 percent since May 22.

Japan's Topix Index peaked at close to a five-year high on May 22 just as trading by clients of the country's largest online brokerages reached records. Tokyo-based Matsui Securities Co. (8628), which gets 65 percent of sales from commissions, said the value of shares traded though client accounts rose to 5.86 trillion yen ($60 billion) in May, beating the previous high of 4.68 trillion yen in December 2005. Turnover reached records at Monex Group Inc., Rakuten Securities Inc., Kabu.Com Securities Co. and SBI Securities Co.

No Insight

To James Butterfill at Coutts & Co., trading by private investors provides no insight into the direction of the market. While the S&P 500 set 17 new highs this year, the last one was May 21. Since then, the gauge has fallen 3.6 percent, posting its first back-to-back weekly retreat since November last month.

"The inflows we are seeing are still coming on the back of very low volume," Butterfill, who helps oversee about $45 billion as head of global equity strategy in London, said in a phone interview on June 5. "Until we see a recovery in volume it is hard to have such a great conviction."

Volume Decline

U.S. equity trading is falling for a fourth straight year, down about 1 percent to 6.38 billion shares per day on average in 2013, according to data compiled by Bloomberg. That compares with the average of 8.13 billion each day from 2009 through 2012.

While trading slips, a TD Ameritrade gauge of client interest in equities is flashing bullish signals. The Investor Movement Index, which uses a sample of customer holdings, positions and trading activity as a measure of sentiment, climbed this year to the highest level since June 2011.

Sentiment is "improving," TD Ameritrade Chief Executive Officer Fred Tomczyk said during a Sandler O'Neill & Partners conference in New York on June 6. "Our clients with their actions have taken increasingly bullish positions," he said. "There's definitely more activity in the market."

Laszlo Birinyi, president of Birinyi Associates Inc. and one of the first money managers to tell clients to buy before the bull market began, says individuals will push stocks higher. The Westport, Connecticut-based investor says flows tend to multiply late in the rally, when gains force skeptics to capitulate, in the last leg he calls exuberance.

ETF Flows

One category that is seeing business improve is exchange-traded funds. U.S. equity ETFs, which group stocks similarly to mutual funds but trade throughout the day, have attracted $79 billion so far this year, according to Deutsche Bank AG and Bloomberg data, on track to beat every annual inflow level since at least 2009.

Brokerages are beating banks and the broader market in Europe. The Stoxx 600 Financial Services Index has gained 12 percent this year, more than twice the 5.6 percent advance for a gauge of European banks. Hargreaves Lansdown Plc (HL/), the U.K.'s largest retail broker, which received record cash in its latest quarter, according to an April 17 statement, advanced 33 percent. IG Group Holdings Plc (IGG), the London-based provider of spread betting, rose 30 percent.

The last time gains in European brokerages exceeded banks by that much, in 2006, the Stoxx Europe 600 Index rallied a further 14 percent in the second half of that year. Brokerages paced the gains, with a 27 percent advance between July and December.

"We are seeing inflows, and I don't think that indicates the end of the rally," said Colin McLean, who helps oversee $620 million at SVM Asset Management Ltd. in Edinburgh, including shares in Hargreaves Lansdown and Aberdeen Asset Management Plc, Scotland's largest money manager. "There is still a lot of money to come in."