So resilient is the current bull market that “buying the dip” has proven to be a near infallible investing tactic.
The pattern is by now familiar. Stocks retreat on the worry of the hour, be it Crimea, China, the U.S. Federal Reserve or plain old generic fear.
Investors then spot a buying opportunity in the pullback, restoring the upward trajectory and lifting the S&P 500 to new record highs.
“A tie goes to the incumbent,” said Greg Newman, senior wealth adviser at the Newman Group, a ScotiaMcLeod affiliate. “We’re in a bull market until the bears prove otherwise.”
While yesterday’s successes could prove to be tomorrow’s failures, buying the dip will remain a compelling trade as long as the market’s key supports – the global economy, the Fed, geopolitical stability, investor confidence and corporate earnings – remain in place.
Over the past year, there have been five periods over which the S&P 500 has declined by between 3 per cent and 6 per cent. Each time, the market has promptly climbed back up.
The latest and largest of those dips began in mid-January after an unexpected slowdown in Chinese manufacturing. Also in January, the Fed began to trim its monetary stimulus program, fuelling an emerging markets selloff. Then the U.S. economy strung together a series of dismal results on housing, jobs, retail sales and industrial production.
On all counts, the panic subsided. The 5.8 per cent the S&P 500 lost by early February was fully restored by the end of the month as bullish investors pounced on the opportunity.
“I see it every day,” said Martin Pelletier, portfolio manager and managing director of TriVest Wealth Counsel, calling the pattern characteristic of a bull market that’s “a little long in the tooth.” Investors anticipating a correction sell at the first sign of trouble, then bullish investors buy on weakness.
“There’s a solid floor under the market right now,” he said.
The security of that floor might encourage investors to add to positions, rather than make all-in bets, when the market stumbles, Mr. Pelletier said. “As long as the Fed is active in the market, this strategy does make some sense.”
While the Fed spooked the market earlier this month by speculating on the timing of rate hikes, it’s clear the central bank is committed to supporting stock values, Mr. Pelletier said. That lends some powerful support to the buy-the-dip argument.
But inevitably, one of those dips will prove to be the beginning of a substantial correction.
Investors need to assess each market slide for its destabilizing potential. If the macroeconomic outlook is unlikely to pose a mortal threat to the bull market, buying on weakness will continue to make sense, Mr. Newman said.
There is likely to be plenty of opportunities to test that rationale.
After five years into a bull market, during which the S&P 500 is up by 175 per cent, investors anticipating a major selloff are sensitive to the slightest negative catalyst.
Also, the memory of the 2008-09 market meltdown is never far from top of mind, Mr. Newman said.
“They keep wanting to put their crash helmet on.”
Many investors are doing what CNBC host Jim Cramer calls “renting stocks,” holding investments temporarily and moving on when share prices start to decline, said Mr. Pelletier. That kind of selling can amplify what might otherwise have been a modest pullback.
“For the long-term value investor, it’s getting more and more challenging to find opportunities in this market,” Mr. Pelletier said, referring to heightened valuations and fewer bargains. “And those are the guys you want investing, they tend to provide longer-term support.”
The decision to buy the dip also requires an investor to set a lower threshold to act on market weakness. Investors waiting for a 10-per-cent decline in the S&P 500, for example, would have missed out on a market gain of 30 per cent since the beginning of 2013.
The past year’s dips of at least 3 per cent, on the other hand, were all recovered within a few weeks.
“The trend really is your friend,” Mr. Newman said.