Should You Buy The Dip?
- May 25, 2022
What everybody wants to know Is this a good time to buy the dip, hold your current positions, or go to cash? I’ve been in this business for over 30 years, and I have learned some tough lessons:
- Market timing is a fool’s game. People confuse being lucky for being good.
- Buying and holding for the long term is a strategy that, near retirement, can keep you working longer than you would like. Look at the Vanguard 2025 retirement fund with an annualized loss of 31.80%.
- Buying the dip only works if the Federal Reserve, aka The Fed, accommodates the Stock market.
Warren Buffet said, “We simply attempt to be fearful when others are greedy and to be greedy only when others are fearful.” Would Warren Buffet be buying this market today? Are investors currently fearful or greedy? The data shows that investors buy at the top and sell at the bottom.
Hasn’t Buying the Dip Always Worked?
Since March of 2009, If an investor had bought the dip, they would have been wildly successful. The market has followed a pattern of dropping then rallying hard during the last 14 years. Every investor and advisor under the age of 35 has learned to Buy the Dip. Looking at the chart from March 2009, the data would clearly show that when the market drops, buy the dip.
However, if we expanded our horizon and looked at the market from 2000 to Oct of 2002, buying the dip would have put you in the poor house.
Why are the average advisor and investor so dedicated to buying the dip? Quite simply, it has worked for the last 14 years.
What’s happening is a behavioral effect called information bias. This type of bias arises from systematic differences in the collection, recall, recording and/or handling of information. The naive investor believes it will work because it has worked in the past. This is combined with recency bias, which refers to our propensity to assign more value to recent occurrences than historical ones.
Winston Churchill believed that the key to the future is to study the past. He remarked, “Those who fail to learn from history are condemned to repeat it.” Not only did I study the past, but I have also lived through several disastrous market crashes. My experience tells me that buying the dip this time could be painful.
There is an old saying on Wall Street, “As goes the fed, so goes the market.” A great example is to look at what happened during the COVID-19 correction of 2020 when the market quickly dropped 35% as the global economy shut down. This period saw The Fed take out a bazooka and drop rates to zero, buying billions of dollars of bonds and adding liquidity into the economy through a process known as quantitative easing. This made the market rebound sharply in the second half of 2020. There was also a robust fiscal component added when the typically dysfunctional Congress worked together to pass a massive financial package for Main Street.
Is the Federal Reserve Going to Come to the Rescue Again?
With Fourteen years of the fed rescuing the markets, why should they stop now?
If you believe The Fed will come to the rescue this time around, you should absolutely buy the dip. But what if they don’t? Then what?
The Federal Reserve, A Triple Mandate?
The Fed was Established in 1913 to control two economic conditions, inflation and unemployment. However, since March of 2009, an unspoken third mandate has arisen: support US stock markets with what is referred to as “The Fed Put.” The chart below shows how the US Central Bank has supported the market every time it has corrected.
The chart below shows how a drastic drop in interest rates helped end the dot-com crash, the financial crisis, and the COVID-19 drawdown. As the market crashed, The Fed drastically dropped rates leading markets to rally.
The Secret to Buying the Dip is the Fed?
After looking at the data, all we must do is figure out when The Fed will stop raising interest rates and begin lowering them again. Inflation today is as high as it’s been since the late 1970s. If you look at how the government has changed the way it calculates inflation over the past five decades, today’s inflation is substantially higher than in the late 70s. Accounting for the change in calculation, the real numbers are substantially higher.
The charts above show that if the government used the same formula to calculate inflation as it did in the 1980s, today’s inflation would be over 16%. The second chart shows that if the government calculated inflation using the 1990’s formula, it would be over 12%. This means that the money sitting in your bank account at zero percent is actually losing between 12% and 16% per year.
The last time inflation was this high was in the 70s & 80s when Paul Volker was the head of The Fed. He started raising rates in the 70s, pushing the fed funds rate (the rate at which banks lend to each other) as high as 20% by the early 80s. This consistent rise in rates collapsed the financial market, shut down the economy, and stopped the rise in prices. Only when the market nominally (before inflation) dropped 42% was The Fed convinced inflation was under control and Volker began dropping rates in late 1982. As shown in the chart below, this drop in interest rates caused the market to rise sharply.
The evidence shows that continually raising interest rates does indeed kill inflation but, unfortunately, also kills financial markets.
Today, Jay Powell finds himself in the same predicament as Volker. He must either tame inflation, ‘his primary mandate, or support markets. Powell, like Volker, is a student of history who knows well what happened to Germany in the late 1920s and how hyperinflation destroys economies. In the end, Volker whipped inflation at the expense of the economy and stock market. Jay Powell, the current head of the Federal Reserve, has publicly stated that his number one concern is
killing inflation. Based on the current state of inflation, can The Fed save the day by using the “Fed Put” to support markets?
Sticky Inflation vs. Transitory Inflation
To understand if Powell can tamp inflation, we must understand what exactly he is trying to tame.
Commodity inflation, energy, new and used cars, food, etc., are transitory (temporary). This is where inflation started with supply chain bottlenecks caused by the COVID-19 crisis but was further exacerbated by the Russia-Ukraine war. If the war continues and Covid keeps popping up, transitory may last for a while.
The larger problem is taming sticky inflation, such as rising home prices, ballooning rent, as well as increasing wages and prices of professional services. I went to park in my usually spot and the price had jumped by 50%. Is your favorite restaurant going to reduce prices when food costs drop? Are workers going to take a salary cut? Will plumbers and electricians charge less to fix your toilets and light bulbs?
Based on the data, It is hard to see how Powell will solve this problem unless he keeps hiking interest rates just like his predecessor Paul Volker did. If you believe the fed is not going to accommodate the stock market like it has done over the last 14 years this time around, then “buying the dip” could put you in the poor house.
Stay Invested and Wear Seat Belts
I’ve always said to my team and students, “What if we can invest but not take a view on the market?” In-other words, build a portfolio that takes an agnostic view of market movement. A portfolio where we are always invested and always protected without playing the risky game of trying to time or predict the market. Such a portfolio would enable you to sleep at night, knowing your money would participate in upside gains while reducing your downside losses through hedging.
Simple hedging can be a powerful tool for managing portfolio risk. A white paper published through the Journey of Investment Consultants addresses this issue. Download the white paper today https://docsend.com/view/t4idvv33wa2swriu
Since 1996, IPS Strategic Capital has grown and protected wealth by generating consistent, non-volatile returns regardless of market conditions. We rely on mathematics, not speculation. We firmly believe there is a better, safter way to invest through the conservative use of options to define tomorrow’s risk, today.
Disclaimer: The information in this article should not be misconstrued as an offer, nor a solicitation, to buy or sell securities. Any past performance of any investment(s) does not necessarily indicate the future performance of any investment(s). No client, current or prospective, should assume the future performance of their investments will be profitable based on historical performance. Any backtest charts and data presented are purely hypothetical and do not represent the performance of accounts managed by IPS Strategic Capital. The results were obtained by applying a rules-based investment process to historical data. All investments have the potential for profit and the potential risk of loss. Changes in investment strategies, contributions, or withdrawals may cause the performance results of one’s portfolio to differ materially from the reported composite performance. Different types of investments involve varying degrees of risk, and there can be no assurance that any specific investment will either be suitable or profitable for a client’s portfolio. One should always consult an investment advisor before making any investment decisions.
One should always consult an investment advisor before making any investment decisions as well as consider the investment’s objectives, risks, charges, and expenses carefully before investing or sending money. This and other important information about the Strategy is available upon request.
