Are nervous investors returning to the ASX stock market right now?

This group of investors could drive a recovery in share prices in the coming months.

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A worried woman looks at her phone and laptop, seeking ways to tighten her belt against inflation.

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Key points

  • Strong inflation and higher interest rates hurt valuations last year
  • But, the latest inflation numbers in the US seem to be suggesting that inflation could be dropping
  • One research outfit has suggested that retail investors could drive the market higher over the next couple of months

The ASX stock market is in the green this morning as investors digest the latest inflation report from the US. The S&P/ASX 200 Index (ASX: XJO) is currently up by 0.95%.

This latest boost for the ASX appears to be inspired by overseas events as the S&P 500 Index (INDEXSP: .INX) rose 0.3% in response to positive signs for inflation. The iShares S&P 500 ETF (ASX: IVV) (the ASX-listed version) return is negative (by 0.4%) amid a weaker US dollar because it trades in Australian dollars.

What did the latest US inflation numbers say?

According to reporting by CNBC, the consumer price index dropped by 0.1% in December, which is what experts were largely anticipating.

Excluding food and energy, core CPI rose by 0.3% — this was also in line with estimates.

Year over year, headline CPI rose 6.5% and core inflation was up 5.7%. Prices at the petrol pump dropped by 9.4% for the month and are now down 1.5% year over year, according to CNBC.

Retail investors predicted to drive the stock market

In 2020, powered by government stimulus, retail investors collectively played their part in driving the stock market higher after the COVID-19 crash.

Interestingly, Vanda Research has suggested that small US investors appear to be coming back to the stock market and could help push shares higher in the coming months, according to reporting by the Australian Financial Review.

Vanda said in a note:

Retail investors tend to buy equities more aggressively in January and February, following weak net buying in November and December. Moreover, purchases typically see a stronger rebound in January when the S&P500 posts poor returns in December during a down year.

While it is difficult to imagine retail activity jumping 3-7x given the already fourfold rise post-COVID, the continued downtrend in CPI inflation recorded in today's print could usher an improvement in risk appetite from very bearish levels, pushing retail flows towards the high end of the monthly purchases range (max $US29 billion in Aug '22).

This could set off another short-term virtuous loop for equities, drawing, at a minimum, some participation from rule-based systematic investors.

The AFR also pointed out that Vanda noted that retail investors reportedly make more investments going into reporting season:

We expect this historical pattern to repeat over the coming weeks, boosting retail purchases. On the flip side, this means that retail activity could start to wane in mid-February after most of the more prominent companies of the S&P 500 will have reported their Q4 results.

Foolish takeaway

The stock market can be influenced by how much demand there is for buying shares. If there's more demand, it could push up valuations a bit. It'll be interesting to see if Vanda's theory plays out in the next few months.

Motley Fool contributor Tristan Harrison has no position in any of the stocks mentioned. The Motley Fool Australia's parent company Motley Fool Holdings Inc. has no position in any of the stocks mentioned. The Motley Fool Australia has recommended iShares S&p 500 ETF. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

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