It’s been a tough year for retail investors — and it’s not necessarily expected to get any easier in 2023. All three major stock indexes are heading towards the end of the year deeply in the red. Wall Street analysts are reducing earnings estimates and bracing for more downside, at least in the first part of 2023. Meanwhile, the average retail portfolio will close the year down about 35% from all-time highs, according to Vanda Research, a global research company that conducts macroeconomic and strategic investment analysis. Yet, that’s not keeping them from investing, said Marco Iachini, senior vice president of the firm. “It’s almost as if we had two different eras — pre-Covid and post-Covid,” he said. “Post-Covid overall net inflow of retail investors has tripled, and almost quadrupled, and stayed there.” He views it as a structural shift due to younger traders being a lot more active and having more access to markets than in the past. Retail traders began pouring into stocks during the pandemic, buying individual names and taking bets on meme stocks such as GameStop and AMC . “In 2021, there was a lot of activity in single names, especially these higher beta stocks, tech stocks, growth stocks,” said Peng Cheng, head of big data and artificial intelligence strategies at JPMorgan. “This year, because the losses mainly came from those stocks, that has led them to de-risk in those sectors.” That risk reduction can also be seen in TD Ameritrade’s Investment Movement Index, which tracks investor sentiment. Other than a “little blip” over the summer, there has been month after month of declining sentiment, said Shawn Cruz, head trading strategist at TD Ameritrade. “Downside shouldn’t continue without a significant drop in the economic outlook and an increase in risk averse behavior,” Cruz said. While retail traders’ money is still coming into the market, their share among the market participants is down from last year’s peak, according to Cheng. In 2021, about 20% of the entire market participation could be attributed to retail investors and now they make up about 15%, he said. Still, that’s higher than the pre-pandemic level of 10%, he added. A focus on quality, ETFs Once retail traders got out of the riskiest stocks, they focused a lot more on quality, said Cruz. “They were finding companies that were already profitable, growing revenue or [had] stable margins, in many cases,” he said. They are also leaning into exchange-traded funds as a way to still maintain equity exposure, investing in fixed-income ETFs, and buying more short-dated options, JPMorgan’s Peng noted. When it comes to individual stocks, retail investors are buying companies such as Tesla , Apple and Nvidia , according to Vanda Research. While not in the top 10 investments, Netflix and Occidental Petroleum also saw big increases in interest, per Vanda Research. Retail investors bought nearly $1.9 billion of Netflix shares, up 1,877% from 2021, while they bought more than $1.7 billion of Occidental Petroleum, a 1,451% increase from the year prior. By comparison, GameStop saw an 83% drop in retail purchases in 2022 from 202, and AMC a 72% decline. Capitulation ahead? Retail investors will likely stick with their game plan into 2023, said Vanda Research’s Iachini. He doesn’t see a more constructive, risk-on environment as investors “remain [in] this muddle through, slower grind lower until we reach a recession.” “We struggle to see retail investors going back to speculation or doubling down on risky bets to try to make up their losses,” he said. They’ll also be closely watching the Federal Reserve to see what officials say about future tightening. The central bank is expected to continue hiking interest rates in its effort to tame inflation. Retail investors are very sensitive to the Fed’s messages, Peng said. “If the Fed continues to maintain this hawkish tone, we will continue to see this negative price action” in stocks, he said. While there have been a couple of soft capitulations by retail traders this year, Wall Street is waiting for the other shoe to drop, Iachini noted. He’s closely monitoring what’s happening with Tesla, which he sees as a barometer for retail investor behavior. The stock, which has lost more than 64% so far this year, has consistently made up about 11% of the average retail portfolio since Vanda Research started tracking in 2014. He’s watching to see if investors start seriously selling. “That is one area we are monitoring in terms of whether that is going to eventually lead to a full/traditional capitulation from the retail investor cohort,” Iachini said. “We, like many others, are waiting for that capitalization to happen.” Once that occurs, it is a contrarian signal for the markets to turn higher.