A Selloff in the Stock Market on Tuesday Put Retail Investors' Dip-Buying to the Test

When markets become volatile and fear sets in, retail investors often see it as an opportunity to buy the dip. This trend was evident again on Tuesday, when markets tumbled after a disappointing report from the Institute for Supply Management (ISM) indicated a slowdown in the U.S. manufacturing sector. The S&P 500 dropped by 2.1%, while the tech-heavy Nasdaq Composite plunged by 3.3%. This marked the largest decline since a global selloff in early August.

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Much like the market reaction in August, retail investors responded to falling prices by stepping in to buy. However, the intensity of this buying wasn’t as strong this time around. Marco Iachini, senior vice president of research at Vanda Research, noted that there was an increase in retail buying on Tuesday, but it didn’t match the higher levels of inflows seen during the August selloff.

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Vanda Research provided data showing retail investors' net buying over recent months, and while the activity on September 3 was higher than most days during the previous six months, it was still below the surge seen in early August. Furthermore, it was lower than the buying on August 22, when the S&P 500 experienced a smaller dip of 0.9%.

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Iachini explained that retail traders tend to behave in a contrarian manner, meaning they often increase their buying when stock prices drop and scale back when prices rise. However, their actions don’t always follow this pattern precisely. For instance, they don’t typically rush to buy during the first dip, instead waiting until stock prices fall further before committing more aggressively.

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This was evident earlier in the summer. In mid-July, when the market first started declining, retail investors didn’t jump in immediately. It wasn’t until early August, when the Nasdaq entered correction territory, that they began purchasing tech stocks at discounted prices. Iachini mentioned that retail investors tend to act more assertively during the second or third market dip, once stock prices reach lower levels.

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Another factor contributing to the less aggressive buying this time around is that retail investors had already been purchasing stocks at higher levels throughout the past month. As a result, some investors may have exhausted their cash reserves, leaving them with less available capital to deploy when stock prices dropped again on Tuesday.

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The San Francisco Federal Reserve had previously released data showing that the excess savings built up during the pandemic have largely dried up. This reduction in savings means that retail investors don’t have as much extra cash on hand to buy stocks during market dips. Iachini noted that many of the retail investors Vanda tracks are heavily reliant on their paychecks to fund their investments. Having already bought stocks during last month’s dip, some may need time to rebuild their cash reserves before they can jump back in.

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This raises the question of how sustainable the dip-buying strategy is for retail investors, especially if markets continue to experience downward pressure. Iachini pointed out that retail investors often either chase stocks at their peak or give in to capitulation at the bottom, signaling a potential turning point in the market. However, he believes that we are not yet close to this point. The quick market rebounds following recent declines have likely strengthened retail investors’ confidence in their buy-the-dip strategy.

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Despite the current market volatility, retail investors remain fairly optimistic. Vanda’s data indicates strong net buying over the past few months, suggesting that investors still have a bullish outlook. Bret Kenwell, a U.S. investment analyst at eToro, offered some insights into why this may be the case. According to Kenwell, two primary factors are supporting this bullish sentiment: the Federal Reserve’s monetary policy and earnings growth.

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Kenwell believes that these two pillars—monetary policy and earnings growth—form the foundation for a bullish market, and both factors look solid at the moment. However, he also acknowledged that the market could face tests in the coming months, with key events like the Federal Reserve’s next policy meeting and the U.S. presidential election in November looming on the horizon. These events could introduce higher levels of uncertainty and volatility into the market.

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While predicting market direction is always challenging, especially during times of uncertainty, experts agree that investors should be prepared for increased volatility in the near future. For retail investors who have adopted a buy-the-dip strategy, holding onto their positions and staying focused on the long term could be crucial in navigating the ups and downs of the market.

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Ultimately, retail investors' recent behavior indicates that they are still betting on the market's recovery, but it remains to be seen how long they can sustain this approach, especially in the face of external pressures like dwindling cash reserves and potential macroeconomic challenges.

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