The stock market is on weak footing as retail investors abandon the 'buy the dip' strategy and turn to higher yielding bonds

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• Retail investors are retreating from their "buy the dip" strategy, according to Vanda Research.
• That's bad news for the stock market as it removes a big pillar of support for stock prices.
• "This will make broad equity indices more susceptible to the whims of institutional investors," Vanda said.

Retail investors are starting to retreat from their "buy the dip" strategy, and that puts the stock market at risk, according to a Thursday note from Vanda Research.

After retail buying activity hit a historic peak in February, net purchase activity dropped below $1 billion per day in early March. Such a decline weakens a significant pillar of support for the stock market, according to Vanda, and that makes the market more susceptible to volatile swings.

"The key takeaway is that a significant pillar of support for this year's rally will likely remain subdued in the weeks ahead. This will make broad equity indices more susceptible to the whims of institutional investors, which remain broadly more cautious on the near-term outlook," Vanda said.

And while a favorable jobs report or CPI data could help revitalize retail investors' demand for stocks over the next week, stocks still face a formidable competitor for investors that plan to put new money to work: bonds.

According to Vanda, bonds are starting to offer an appealing enough rate of return that could siphon retail money that would typically go into the stock market. Short-term US Treasuries are hovering close to the 5% level, which is an attractive prospect given they're as close to risk free as an investor can get.

"With the US Treasury 10-year yield at 4%, flows suggests growing retail interest in locking in these higher yield levels. For equities, the risk is that retail appetite for bonds could siphon away some crucial demand right before key events in March," Vanda said.

As the stock market adapts to declining demand from retail investors, institutional players could have more influence over stock prices, and not in a good way. That's because option flows data suggests institutional investors are growing more cautious towards stocks ahead of the February jobs report and inflation data.

"Option flows indicate [institutional investors] have taken on a more defensive stance in recent days and will likely avoid upping risk exposure in a meaningful way at least until there is more clarity from the FOMC on March 22," Vanda concluded.

The Fed is expected to hike interest rates at the upcoming meeting on March 22 by at least 25 basis points, but officials have indicated they could return to 50 basis point rate hikes if the job market continues to show strength.

Either way, don't count on retail investors to shore up support for the stock market as long as bond yields remain at such attractive levels.