The market’s 2022 slide has already changed investor behavior

The 2022 slump in US equities intensified last week, with stocks showing their on Thursday biggest drop in one day since the start of the pandemic. The plunge came just a day after Federal Reserve Chairman Jerome Powell appeared to be paving the way for a stock rally by considering rate hikes of more than half a percentage point unlikely.

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The magnitude of Thursday’s decline and the recent wave of volatility raised questions about bigger problems in the markets, such as the settlement of leveraged trades or the possible liquidation of funds after large misbets. But many investors and analysts say the move was largely in line with the broad pullback from the market this year, driven by expectations that interest rates will rise. Portfolio managers say rising interest rates tend to benefit dividend paying sharesfor example, while adding to the pressure on speculative trades that were popular and profitable when money was free.

For stocks, that trend hurt the shares of companies that have risen during the pandemic years and have high valuations.

Netflix Inc.,

NFLX -3.90%

one of the hottest tech stocks in recent years, is down 70% this year.

Amazon.com Inc.

AMZN -1.40%

is down 31% and is even lagging behind the slumping major stock indices. Below we discuss some signs of the turmoil in the markets when: buy the dip no longer pays immediate, predictable benefits.

Cracks in the market

The size of the market sell-off was striking. Few stocks have been spared.

According to FactSet, just 35% of shares in the S&P 500 traded above their 200-day moving average on Thursday. That was down from 74% in January. Within the Nasdaq Composite, just 20% of shares traded above their 200-day moving average that day, up from 38% in January.

“There’s a lot of weakness under the surface,” said Willie Delwiche, investment strategist at All Star Charts.

The defeat has dragged stock market valuations down.

However, even after recent declines, the S&P 500 still looks expensive compared to its valuations of the past decade. The S&P 500 last week was trading 17.7 times projected 12-month gains, according to FactSet, above the 10-year average of 17.1 times earnings. With the Fed poised to tighten monetary conditions further, many investors say equities still don’t look cheap.

Options buzz disappears

As stocks plummeted, investors have tempered their enthusiasm for risky bets in the options market.

For much of the past two years, individual investors had rushed into the options market to place ultra bullish bets on stocks. Options betting became synonymous with the frenzy surrounding meme stocks, as stocks of companies like

GameStop Corp.

GME -3.72%

and

AMC Entertainment Holdings Inc.

AMC -6.33%

rose.

Now much of that speculation seems to be leveling off. According to Deutsche Bank, net call option volumes in single stocks recently hit their lowest level since April 2020.

According to Credit Suisse, the price of bullish options on stocks has also started to decline relative to bearish options. That’s a reversal from much of the past few years, when investors looking to bet more on certain stocks fueled rising demand for bullish options.

cryptocurrencies slide

Other risky markets have taken a hit. Bitcoin prices spiked in March this year and have generally fallen to about $36,000 since then.

The cryptocurrency’s decline has likely had a devastating effect on not only individual investors, but a growing number of institutional investors as well. While cryptocurrencies in their early days were mainly bought and sold by retail traders, hedge funds and registered investment advisors have gained a greater presence in the markets in recent years.

Pessimism is growing

Because defeat has left money managers with few hiding places, studies have shown that individual investors are becoming increasingly pessimistic about the stock market.

According to the American Association of Individual Investors, the proportion of investors who believe the stock market will fall in the next six months to April is at its highest level since March 5, 2009.

Widespread pessimism isn’t necessarily bad news. Some analysts view the AAII survey as a contrarian indicator, betting that when sentiment appears to have soured to extreme levels, markets will be poised for a rebound. (In 2009, the S&P 500 hit the bottom of the financial crisis, just four days after the AAII reading.)

“Sentimental data can well say that if we’re not exactly at the bottom end of the market, we’re probably in the margins,” said Ross Mayfield, investment strategy analyst at Baird. “So if you’re very tactical, those are the good times to put money to work.”

One of the reasons some investors are hesitant to look at the markets these days: inflation. After factoring in price increases, the S&P 500’s earnings yield has fallen dramatically. That has made it harder for investors to justify paying a premium for owning stocks over other investments, Morgan Stanley Wealth Management said.

Some investors bracing for further turmoil are turning to inverse funds, which offer buyers the chance to bet on declines in stocks or indices. According to Jason Goepfert, founder of Sundial Capital Research, activity in such funds recently reached its highest level in the past decade.

“Retail investors are betting against stocks,” said Mr. Goepfert. “They hedge their wallets.”

write to Akane Otani at akane.otani@wsj.comKaren Langley at karen.langley@wsj.com and Gunjan Banerji at Gunjan.Banerji@wsj.com

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