Are you buying the dips?

The stock market has been a wild ride lately.

Amazon was up 8% in a day this week and the NASDAQ 100 ($QQQ) has been a star performer year-to-date.

But things have been up and down and I bet you have been eagle-eyed and watching for any dips. Wanna get those bargains – right?

Except if you have read my blog at all you will know that I will not be buying the dips.

Steady as She Goes

I’m a fairly staunch buy-and-hold investor in low cost index funds.

I know… yawn! You wonder why I don’t post much? Well, that kind of strategy doesn’t make for good blogging material I can tell you!

I’m also not a fan of keeping cash, or ‘dry powder‘ on the sidelines (That Dry Powder You Have? (You’re Better off Snorting It). I do occasionally foray into other asset classes like high yield bonds (Looking for value in the current market) or long Treasury bonds (The market is crazy! No, not the stock market; bonds!) but mostly keep things fairly vanilla.

But I can see the attraction of ‘buying the dips’. If you can identify temporary dips in stock prices during periods of volatility then you will surely see a boost in returns compared to simply buy-and-hold.

But this is the problem, I don’t really know whether this strategy works because I’ve never seen any compelling data and evidence from a real-life investor.

Prove It!

My Twitter timeline has frequent periodic tweets from people claiming to have identified a dip in the price of a stock and musing on whether now is the right time to buy. This is often accompanied with some information on the dividend, so I think buying the dips must be a common strategy for the dividend investing crowd.

However I’ve never seen a clear illustration of its effectiveness.

I want to see a clear comparison between the returns of someone’s portfolio from buying the dips with the accompanying opportunity cost of keeping assets in cash, alongside the returns of a simple buy-and-hold strategy.

I’m simply skeptical of the regular Joe’s ability to buy the dips effectively. Perhaps you are not a regular Joe (and I suspect my readers are not), in which case direct me to your trades.

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Other Investors?

What do large sophisticated institutional investors do?

Large pension funds, endowments, sovereign wealth funds, insurance accounts… Do they buy the dips?

Absolutely not.

There is no way the investment committees or Chief Investment Officers of these institutions are dabbling in this practice. The main reason is governance and accountability. Buying the dips is not perceived as a practice that might result in a reasonable excess return for the additional risk.

They might employ a specialist equity manager with a quantitative trading method to boost returns through volatile periods, but that manager’s feet are held to fire. Their quarterly returns are compared to those of a passive investment and if (net of fees) the returns lag then they will be fired.

So while in the institutional world of investing there may be some form of buying the dips, there is an accompanying governance and accountability framework.

Putting the Market in Context

I bet you’re wondering two things.

Where is this article going, and where are the groovy charts?

Well, my assertion to you is that there is an imminent dip coming.

I’m sure of it.

Let’s put the current market in some context. We have had the largest bipartisan fiscal stimulus in history, and part of that package was a temporary $600 a week enhancement to the federal unemployment benefits. This is due to expire next week.

This has had a big impact on workers’ incomes and during a period of the sharpest increase in unemployment we’ve actually see hourly earning rise! It’s crazy, but see below.

So you cannot deny the additional unemployment payments have had a big impact on many, many people. It’s been a big deal and it is due to disappear with no clear succession plan at time of writing.

The Senate has been presented with the Democrat proposal for extending the stimulus and are formulating their counter-proposal. This will be played-out with good-old Capitol Hill brinkmanship.

My assertion that there is a dip coming is simply the observation that the market hates uncertainty. And the delay of any fiscal extension presents material enough uncertainty to move the market. I’m asserting to you now that over the next week or two there will be volatility and the market will dip.

I’m not bold enough to claim a significant re-pricing in equities, or a double-dip, or a W-shape recovery. I’m simply making a pretty prosaic claim of heightened volatility.

But check out this chart to back me up.

The Next Dip

The above chart shows the VIX over the last 5 years. This is a measure of the volatility in the stock market. It is one measure, and not a perfect measure, but it’s not a bad guide to the ups and downs of stocks.

I’ve noted in the above chart all the occasions where Congress had to agree to a new Federal debt ceiling. I think it’s fairly clear that the preceding weeks were accompanied by elevated stock volatility as the market tried to parse out whether, and when, a new ceiling would be agreed. Upon agreement the market breathed a sigh of relief and settled down.

There are a million factors impacting market volatility and this is not the most scientific analysis I’ve ever done but it’s pretty compelling if you eyeball it and squint.

My Challenge to You

I’ve given you a dip on a plate!

I’m literally laying out a compelling thesis for an imminent dip.

We are in the middle of a significant fiscal debate in Government and this will make the market more volatile. In the coming week or two there will surely be opportunities to buy.

So if you are a paid up member of the “buy-the-dip” crowd then I want you to impose some governance on your investment process. Send me your trades and I will calculate the value-add. Let’s compare your returns over 2020 of buying-the-dip and holding cash until the trade-date, versus simply buying-and-holding over 2020.

I haven’t done all the work for you. I’m not able to identify the bottom of the dip or the best point to enter the market, or even what stocks to buy. I’m going to leave that to you. But honestly, I’ve done about half the work – right?

Let me know how you get on.

Bottom line Do you try and buy the dips? Do you agree with me that there are likely to be some dips over the next couple of weeks until we get resolution of any new fiscal stimulus? Do you accept my challenge to assess how well you did over 2020 with your strategy? Comment below!

Author Bio: I started actuary on FIRE as I did not see any actuaries taking a prominent role in the personal finance area and wanted to remedy a shortage of actuary jokes and write for those that appreciate rigor with fancy charts. In my regular day job I advise corporate US on investment and retirement strategies. I’m a qualified actuary, investment adviser and have a PhD in mathematics and reserve the right to have the occasional math post.