Buying the Dip, but When?
Buying the dip always makes sense if you want a sleep-at-night type of portfolio rather than buying strength. The question, as always, is what do you buy and when do you buy it? We almost always focus on the S&P 500 because it represents almost 40% of the world index and about 75% of the US market cap. Through that lens, we are not anywhere close to buying the dip unless you are talking about day trading. The strategic buyer should still be cautious with their cash.
I first start with a long-term perspective on the trend of the market. All will know this is the longest modern-day economic expansion without a recession (and most fragile), but we are getting closer to an inflection point suggested by the inverted yield curve that is our best recession forecasting indicator. The basics of trend analysis continues to show a pattern of higher highs and higher lows for the US stock market, which suggests that we should be buying dips. Beyond the US market, however, we do not see the same patterns. Just about every other market in the world is well off their all-time highs. And at an inflection point, when the trend changes, those dips get bigger and take longer to recover. The thing is you cannot ever wait for the trend change to be confirmed because buy that time the markets are often 20% or more below it’s high watermark. The average dip (drawdown from a previous peak) for the S&P 500 is 13.4% historically going back to 1926. In a recession, that dip averages more than double that rate or about 29%. With an inverted yield curve, the odds are ever increasing that the next dip is much deeper and takes much long to come back.
But when you buy also depends on what kind of investor you are. Are you a longer-term strategic investor that wants more sleep-at-night, or are you a more opportunistic short-term trader that is looking to add value on a shorter term basis. My style has a bit of both in it. The last dip was 20% and if the trend is changing, the odds are the next dip is more than 20% and when it bounces back, it does not make a new high.
Now here is the whole rub of being a technical analyst, you will never know with certainty how the next period of volatility will play out until after the fact. Therefore, we must take a sum of the evidence approach and look at the probability of something happening, which adds lots of uncertainty. From our perspective, with the longest (and most fragile) expansion in history in place, we need to be far more cautious than aggressive in our portfolios at this point in the cycle—it’s the most prudent approach. With this in mind, were does the short-term investor put some money to work and where does the more conservative investor put some money to work?
At the recent lows, we can see some trendline support and from the perspective of a few days to weeks, perhaps the range day area around the May low (273.09-276.55) makes sense to put some money to work. But do not put all your money to work at that point. In our estimate, the odds it breaks it still very high. But the thing is, we should get a bounce of some degree as the market ebbs and flows. You need to decide if you’re that nimble to be a trader vs. investor. For the more conservative investors, we have to look at the range around the December 2018 lows (235) to dip your toes in. Until we see one of those areas tested, make sure your portfolio is positioned that the daily ups and downs allow you to sleep-at-night. No fear of missing out if markets make a new high and no panic if those levels break.
I often get asked what type of portfolio is right for “Me!” The answer should be based on a portfolio that meets your longer-term retirement needs while minimizing your emotional influence to either chase markets higher or panic at the wrong time and sell into a decline you should be buying. The trouble with the traditional balanced (60:40) portfolio is that extremely low bond yields makes it impossible to passively build that portfolio going forward. And if you’re relying on security selection (stock and bond picking) to deliver you that balance, you’ll likely be very disappointed. So for conservative investors that like the philosophy of my $ZZZD.TO ETF, it provides the traditional sleep at night balance while looking to me for tactical opportunities. Last week I reduced risk in the portfolio buy adding exposure to the US$. I’m looking at the range around the 2015-2016 consolidation range before I get back to investing mode. Between now and then, there are pockets of opportunities is the UK, Japan and parts of emerging markets that have some value opportunities. Trade well and be nimble until we get there—it’s likely coming and will be a referendum on President DJT!