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Buying on the dip: Brilliant move or a bunch of baloney?

Matt McNulty

After Friday's dramatic 623 point drop in the Dow Jones, some investors turned their eyes towards Monday ready to "buy on the dip."

But is buying on the dip a brilliant move or a bunch of baloney?

Buying on the dip” has been a tried and true strategy during this lengthy bull market, however recently two UBS analysts warned traders that now is the time to put the dipper down..

“A world where leading indicators are accelerating is generally one where a correction in equities is an opportunity for investors and ‘buying the dip’ gets rewarded. In contrast, today’s backdrop with PMIs [purchasing managers indexes] in the low 50s and rates arguing for further declines often results in buying the dip being a losing proposition,” strategists Francois Trahan and Samuel Blackman said in a note earlier this week.

"The market has been volatile although we should keep two things in mind," said Fox Business Network anchor Charles Payne. The first is getting "greater clarity on trade" but Payne, the founder of the Wall Street Research firm Wall Street Strategies adds, "Wall Street came to the conclusion long ago a resolution was a long ways off."

The second market matter to note says Payne is getting a better understanding of "how far the Fed will go to keep the economic expansion going.  Both those could be answered during month of September."

But history is also worth noting if you are looking to "dip"

Trahan and Blackman assert that going back to 1974, throughout the past nine full economic cycles, “buying the dip” is most effective when PMIs are accelerating. (PMIs are survey-based indicators that measure private-sector business activity. A reading above 50 indicates activity is expanding, while a reading below signals contraction).

In what the analysts call a “risk-on” period,  “dip buying” has nearly a perfect record during that “risk-on” phase, but not so much during the “risk-off” phase, where the performance of “buying the dip” is mixed at best and that is when PMIs dip below 50, in what’s known as a “risk aversion” phase.

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Following an 18-month lag in interest rate yields, Trahan and Blackman warn “the path laid by interest rates 18 months prior to today shows that there is now tightening in the pipeline, and it’s more likely we experience multiple contraction than expansion in the months ahead.”

With a “risk-off,” contraction phase now entering into effect, “dip buying” may not be entirely advisable. In fact, analysts claim the risk/reward for “buying the dip” under the current conditions is “extremely poor.”

On today's edition of "Making Money," Payne said he had two guests who watched the market dip turn into a drop. "Both agreed the market is oversold but they disagreed on when to actually dive in," said Payne.

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