Should you buy the dip?
It’s smart not to panic in a falling market. But that doesn’t mean you should get aggressive instead.
When equity markets fall, there’s always a chorus urging you to take advantage of the opportunity to buy stocks for less than they cost the day before. Everyone loves a bargain, and after 11 years of a bull market, the S&P 500’s 11 per cent plunge during the week of February 24 made for the worst-performing five-day stretch since the financial crisis more than a decade ago. Even Larry Kudlow, head of President Trump’s National Economic Council, said investors should heed the old advice to “think about buying the dip”.
Plenty did, for a moment at least. The S&P 500 rallied 4.6 per cent on Monday. Then it wobbled again, dropping even after an emergency 50-basis-point cut to the Federal Reserve’s benchmark rate, before climbing the next day. It will likely rise and fall dramatically again and again while the markets grapple with the spread of Covid-19 and what it means for the global economy and the risk of a recession. Meanwhile, the bond market keeps flashing signs of economic anxiety: traders are willing to pay so much for safe-haven bonds that the ten-year Treasury yield slid yesterday to 0.7 per cent (yields fall as bond prices rise.)
This is the trouble with buying the dip: it’s basically a form of market timing, which even professional traders can rarely do well for very long. Many investors planning for a long-term goal such as retirement do themselves no favors by letting market noise creep into their consciousness and narrow their vision. It doesn’t make sense to abandon a well-thought-out asset allocation because one part of a portfolio may suddenly appear cheaper than it was a few months ago.
Cheapness is always relative. What feels like an ugly downdraft looks inconsequential in light of the market’s stubborn climb over the years. From March 9, 2009, through February 21, the S&P 500 had a price gain of 393 per cent. Against that, even an 11 per cent plunge hardly gets you to bargain-basement prices.
Of course, what really matters isn’t the price alone but the corporate profits and growth you get for your buck. It’s not clear yet if you can discern by looking at, say, price-to-earnings ratios whether stocks are really a better buy now. “As markets fall, we are also seeing earnings estimates fall and are not sure where they are going to settle,” says Katie Nixon, chief investment officer for the wealth management business at Northern Trust. “When you don’t know the ‘e’ in p-e, it’s hard to say whether the market is cheap.”
This process could take a while: Richard Bernstein, chief executive officer of Richard Bernstein Advisors, says Wall Street analysts have been slow to lower their profit estimates in response to the outbreak, because they typically wait for company guidance before making adjustments.
Investors with workplace retirement plans who actively buy into the dip may actually be double-dipping. Since employees have money deducted from their paycheques and automatically moved into their funds every month or so, buying into the market even when it drops is already baked into the plan for many people.
It does make sense to rebalance portfolios periodically, adjusting allocations when market moves push your mix of stocks and bonds far away from where you want it. But again, that readjustment often happens in portfolios without people having to do anything. Popular target-date mutual funds — all-in-one investments that split assets among stocks and bonds based on an investor’s age — are designed to rebalance assets over time. Many of the new online investment services known as robo-advisers offer a similar service.
One helpful thing investors can take away from the current volatility is a better reading on their own tolerance for risk — a gut check. If you didn’t before, now you know what an 11 per cent drop feels like. “Talking about risk is an academic exercise if it’s not happening to you,” says Paul Simons, president of private banking, wealth, and trust at Boston Private.
For younger investors, it may be difficult to know how much risk you can stomach if all you’ve known since you had significant money to invest is a bull market. “To clients that started working with me in 2010, I look like a genius because I don’t carry the baggage of the financial crisis,” says Darla Kashian, a financial adviser with RBC Wealth Management in Minneapolis.
Kashian says a good thing about the market chaos is that it opens a conversation with clients: “Do we still really believe what we believed before, and are we in consensus about goals and objectives?” Or, as she puts it more bluntly, “What are you really afraid of?”
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