The “buy the dip” chatter seems to start earlier and earlier each time there is a minor pullback in the market. A few weeks back, I outlined a number of red flags that suggested market weakness was likely to follow. Following that writing, the S&P 500 would start to decline, and was down a little over 1% when the following question was posed to nearly every guest on the financial television networks: “Do you buy this dip?”
Buy what dip, I thought to myself. We weren’t even down 2% from the recent high. This is how powerful sense of entitlement has become, where investors are so conditioned to assume that that market can never go down that they start talking about buying a dip when there isn’t even a dip to buy. Not to mention the fact that one cannot “buy the dip” unless one raised cash in advance of the dip, which is impossible for most market participants given that cash allocations fell to a 14-year low in July.
From a sentiment standpoint, this early buy the dip talk is not a welcoming sign, and is consistent with my argument that there is no longer a wall of worry in the market. Much if this bullishness stems from the perception that volatility is low and will stay low forever which encourages risk taking as equities are assumed to be a risk free asset class. As I wrote in “The Less Traveled Road to the 200-day Moving Average” and “Perception vs. Reality: Are Investors Still Living in 2013?,” though, there is reason to believe that the market environment is slowly changing here. What is lost on most investors is that we are almost seven and half months into the year and the average U.S. stock is down on the year.
The S&P 500 reached a peak-to-trough decline of 4.3% last Thursday. The “buy the dip” question continues to be posed, but again, is it even a dip yet? As you can see by the table below which outlines corrections since March 2009, it has been over two years since the S&P 500 has suffered a pullback of 10%. Given that backdrop and the longest streak above the 200-day moving average in history, investors have redefined the word “dip” to mean any decline that lasts more than a day.
An Oversold Bounce
A number of indicators reached oversold levels last week from which a short-term bounce was a high probability. One such indicator was the percentage of stocks above the 50-day moving average, which reached its lowest level since late 2012.
The McClellan Oscillator also reached an oversold level for the first time since last August.
We have indeed seen a minor bounce following these oversold readings and investors seem quite happy to buy into this bounce here as they have been rewarded with such behavior over the past few years. The assumption is that nothing has changed and we are still operating under the 2013 playbook of straight up moves to new highs following minor dips.
But is this assumption still valid with the average stock down this year and long duration Treasuries continuing to move higher, even during the recent bounce? I would argue that it is not. Given the persistence of defensive intermarket signals, the risk/reward in U.S. equities has changed this year and not for the better.
The Second Leg and Most Pain to the Most Participants
The S&P 500 has experienced a minor decline thus far and after bouncing from oversold levels over the past week investors are assuming this is a buyable dip no different than the many others since the start of 2013. What is lost on these investors is the reality that we are not in 2013 anymore. Investors and traders today would do well to remember the pre-2013 market environment where every minor decline is not followed with a straight up move to new highs.
Markets rarely move straight down, particularly following the strongest uptrend in history. It takes time to break such a strong positive feedback loop and there will be bounces along the way. But make no mistake about it, it is slowly breaking as the average stock is down this year and we get closer and closer to the “Fed Prisoner’s Dilemma” with the end of QE in October.
The final straw to break the back of positive sentiment override is, of course, price. Only when the now deeply ingrained rule of buying every minor decline leads to an actual loss will market participants begin to question such a strategy. There is a saying that the market tends to follow the path that causes the most pain to the most participants. A second leg down here, continuing on the less traveled road to the 200-day moving average, would certainly be the most painful path.
This writing is for informational purposes only and does not constitute an offer to sell, a solicitation to buy, or a recommendation regarding any securities transaction, or as an offer to provide advisory or other services by Pension Partners, LLC in any jurisdiction in which such offer, solicitation, purchase or sale would be unlawful under the securities laws of such jurisdiction. The information contained in this writing should not be construed as financial or investment advice on any subject matter. Pension Partners, LLC expressly disclaims all liability in respect to actions taken based on any or all of the information on this writing.
CHARLIE BILELLO, CMT
Charlie Bilello is the Director of Research at Pension Partners, LLC, an investment advisor that manages mutual funds and separate accounts. He is the co-author of two award-winning research papers on Intermarket Analysis. Mr. Bilello is responsible for strategy development, investment research and communicating the firm’s investment themes and portfolio positioning to clients. Prior to joining Pension Partners, he was the Managing Member of Momentum Global Advisors, an institutional investment research firm. Previously, Mr. Bilello held positions as an Equity and Hedge Fund Analyst at billion dollar alternative investment firms, giving him unique insights into portfolio construction and asset allocation.
Mr. Bilello holds a J.D. and M.B.A. in Finance and Accounting from Fordham University and a B.A. in Economics from Binghamton University. He is a Chartered Market Technician (CMT) and a Member of the Market Technicians Association. Mr. Bilello also holds the Certified Public Accountant (CPA) certificate.
You can follow Charlie on twitter here.
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