‘Buy the Dip’ Faith Has a Last Bastion: Individual Investors

Contrary to their caricature as the fickle winds of finance, individual investors are the only ones keeping the “buy the dip” faith alive. But even their appetite for losses may have limits.

The S&P 500 index is close to notching its worst first half in decades, yet individual investors have still purchased a net $24 billion worth of U.S. stocks over the past month, in line with the average of the past two years, according to the latest data published Wednesday by flow tracker VandaTrack. Even purchases of single equities, which are typically more susceptible to shifts in sentiment than those of exchange-traded funds, have remained robust, unlike during the Covid-19 selloff in February 2020 and the late-2021 rout.

The difference between the premium paid on contracts that give investors the ability but not the obligation to buy stocks—“call” options—and those that allow them to sell—“put” options—has narrowed across the board. This shows that an increasing number of investors think risk in the stock market is tilted to the downside. Still, the move has been much larger for options traded by institutional investors. On balance, these are now positioned for further declines, whereas their amateur counterparts remain cautiously optimistic.

Individual investors are often contrarian, but they are going as far as taking the other side of the trade in cryptocurrency stocks. That is despite a widespread liquidity panic that could mark the beginning of the end for a big chunk of this speculative industry.

Many of the sophisticated risk gauges watched by institutional investors are flashing red as central-bank interest-rate increases risk tipping the economy into recession. But individual investors aren’t oblivious to this either: Surveys by the American Association of Individual Investors reveal the most negative sentiment since 2008.

So what is going on? One hypothesis is that, after years of stock-market rebounds on the basis that “there is no alternative,” savers may simply have been primed to play the long game. Conversely, professional money managers with supposedly long-term investment mandates can face a lot of short-term client pressure.

American households, who often save a fixed amount of dollars into stocks every month, accumulated roughly $2.8 trillion in excess savings during the pandemic, official data suggest. They might have the liquidity to afford investing a larger regular sum in risky assets, as well as the confidence: Despite worries about inflation and economic growth, labor markets remain robust.

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Net retail flows rose eightfold in 2020, the first year of the pandemic, and this step up hasn’t reversed. Both official flow-of-funds data and ASCII surveys show that the share of their portfolios U.S. households allocate to stocks jumped during the Covid-19 crisis to hover around historic highs, and has only come off slightly this year.

However, investors of any stripe can only tolerate so much pain. As of Tuesday, the average retail portfolio measured by VandaTrack was down 32% from its previous peak. And this hasn’t been a lightning-fast correction like in early 2020, but painfully drawn-out across six months.

In fact, their willingness to buy the dip has progressively weakened in recent weeks, with more of their money going into ETFs that bet against the market. Cash buffers keep rising, mostly at the expense of bonds—data by EPFR Global show a massive outflow from fixed-income funds. But equity allocations are also increasingly affected.

This week’s reprieve in the stock market could help individual investors keep the faith. But if the selloff resumes and they stop believing that the market can fly, they might also remove one of the few forces keeping it in the air.

When markets are turning downward, some investors try to make a profit by using a strategy known as buying the dip. WSJ’s Gunjan Banerji tells us why this approach is risky in today’s volatile market, even though it can be tempting. Illustration: Reshad Malekzai

Write to Jon Sindreu at [email protected]

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