Unconventional wisdom: Should you buy the dip?
In the face of Trumpian policy whiplash and dire economic predictions many investors have one response – buy the dip.
Conventional wisdom is a byproduct of groupthink that presents solutions good enough for the average person while simultaneously not being right for any individual. You follow it at your peril. The more different you are from the person that defined a rule the less you should follow the rule. Each Monday I will challenge the investing norms that just may be holding you back from living the life you want.
Unconventional wisdom: Should you buy the dip?
“The key to good decision making is not knowledge. It is understanding. We are swimming in the former. We are desperately lacking in the latter.”
- Malcom Gladwell
Everywhere I turn I am hearing from the buy the dip crowd. This is the group of investors that loudly proclaim shares are ‘on sale’ after every drop of the market. It is clear there are a lot of them.
The AFR reported record trading volume of investors buying shares and ETFs on April 3rd. 4th and 7th as markets plunged. The AFR cited Nabtrade, Stake, Pearler and Superhero as examples. The last three platforms are popular with millennial and Gen Z investors.
There is no use dancing around this. Sometimes you just need to call a spade a spade. Buying the dip is market timing. I know there are people that object to that terminology. Market timing is bad. And the buy the dip crowd knows better than to time the market. But that is what they are doing.
I don’t have a problem with it. Buying shares that are temporarily cheap is in my investment strategy. Furthermore, Warren Buffett is a market timer.
When Buffett made his much-praised investments into Bank of America and Goldman during the global financial crisis that was market timing. Building up lots of cash when Buffett can’t find anything to buy is market timing.
Since most investors time the market in some way the real question to ask is if buying the dip right now is a good idea. I happen to think a lot of the people doing it - while loudly proclaiming how savy of a move it is - have little basis for their actions.
Instead of making informed choices I think they are following a playbook that has worked in the last few years. Before trying to make a rational assessment of where we are it is worth exploring what might be driving the buy the dip crowd.
Is a learned bias impacting your view?
The concept of tabla rasa is traced back to Aristotle. Yet it might be John Locke’s An Essay Concerning Human Understanding that best describes the concept.
Locke’s essay explored the way humans acquire knowledge. Locke argued that humans start as a blank slate – tabla rasa. According to Locke we are born with no innate knowledge and learn through sensation and reflection. Sensation is acquiring simple ideas through experience. Reflection forms complex ideas by aggregating all the sensations.
Given this context there are some question worth asking yourself. How did you form your investing approach? What are the simple ideas you’ve acquired through sensation? How have you aggregated these simple ideas into the approach you’ve taken?
I started investing on my own at the tail end of the .com bubble. Then came the crash. A drawn-out bear market like the early 2000s is full of sensations. Any optimism from a rally is quickly crushed by more loses. This happened repeatedly over years.
The same thing happened later that decade. The crash after the global financial crisis was also brutal and prolonged. It was also psychologically challenging as bad news followed bad news.
In the face of long and soul-destroying bear markets it is perfectly rational to aggregate each of those negative sensations into a view that investing is not for you.
Many investors simply give up. I kept going but to dismiss the influence of my early experiences on my current view would be naïve.
We can compare that with investors who started after the global financial crisis. It is easy to understand why many of these investors have aggregated their experiential sensations into a view that markets always quickly bounce back.
The epitome of this experience was the Covid crash. The average length of a bear market is 289 days. The Covid bear market was 33 days.
The recovery was equally rapid. It took only four months to get back to the pre-crash level. A year later the market was up 79% from the low. What is the logical conclusion from this experience? It is buy the dip and buy it quickly.
This has been reinforced by other experiences. There were two corrections or falls greater than 10% for the S&P 500 in 2018. One lasted only 2 weeks and the other 12 weeks. In 2023 there was a correction which took 13 weeks to recover. The 2022 bear market lasted 40 weeks in the US but in Australia the ASX 200 never even got to correction territory.
For people whose formative investing experiences occurred after the global financial crisis it is perfectly reasonable that their instinct is telling them shares are on sale.
In my case it is reasonable for my instincts to suggest patience and think things can get much worse. Perhaps that explains why i’m cautious even though buying temporarily cheap shares is at the core of my investing strategy.
Thinking about the biases that may influence your thinking is time well spent. All of us have them. Acknowledging them is the first step in trying to be more rational.
What should you do?
I’m focusing on broad choices investors can make about the share market. And I’m going to contextualise these choices using a broad definition of market timing.
Market timing is moving money into or out of the market or switching asset classes based on predictions of future market movements. To reiterate, most investors time the market to a certain degree.
If you pick one investment in your portfolio to direct new savings that is technically market timing. If you hold back investing new savings for any reason that is market timing. To not time the market requires a completely passive approach.
With that in mind here are the four options investors have:
Option one: You sell because you think the market is going down and prices will be cheaper later. This is market timing to the extreme.
Option two: Stop investing any new savings or other cash flows like dividends and hope for lower prices in the future. This is a more benign form of market timing.
Option three: Stick with your plan. If your plan is to save money and buy shares and reinvest dividends then keep doing it. This is the stay the course dollar cost averaging approach. This can be a more benign form of market timing depending upon how you direct those funds.
Option four: Find every cent you have and buy. This is the buy the dip plan. This is also market timing and the degree is based on how much you are ‘finding’ to invest compared to your current portfolio.
Which option you select should be mostly based on your personal circumstances and investment strategy. If you are 25 the impact of selecting the wrong option is different than if you are 65 and hoping to retire next year.
Option four is the most intriguing of the choices. It could be a blatant case of ignorant market timing. It could be a savvy move to buy undervalued shares.
When it comes to buying the dip it all hinges on one big question....are shares cheap?
Are stocks on sale?
I’m hearing a lot of similar quotes from the buy the dip camp. Buy low, sell high…buy when blood is running in the streets…be greedy when others are fearful. You get the point.
I love these quotes. I completely agree with the overarching theory. Yet it is predicated on shares being cheap.
Shares are on sale from a price perspective. Share prices used to be higher and now they are lower. To me the picture is less clear from a valuation perspective.
The following chart outlines the price to fair value for the shares in our coverage universe in Australia and the US by sector. I waited to publish this article until Saturdy the 12th of April to get the end of week numbers since the market is moving so quickly.
I have taken the average price to fair value of each share which would differ from a market capitalisation weighted index.
The following chart is the same view of markets prior to Trump’s backflip on the 9th of April.
Both markets are undervalued. Most sectors are undervalued. There may some pockets of value out there.
Yet even on a relative valuation basis the markets are still overvalued. The S&P 500 would have to fall 25% for the cyclically adjusted price to earnings ratio to hit the average level since 2010.
How you choose to interpret these valuation levels is up to you. I would like to see a bigger margin of safety before deviating from my plan to blindly buy.
The margin of safety is the difference between what you think a share is worth and the price. It accounts for imprecision in the valuation estimate and the unpredictability of the future.
The buy the dip crowd likes to justify their actions with Buffett quotes. Here is another one, “The stock market is a no-called-strike game. You don’t have to swing at everything – you can wait for your pitch.”
I know that is a baseball analogy but it makes more sense in a test cricket context. You don’t have to try for a six on every ball. Patience is key.
I don’t think we’ve reached a point where shares are cheap enough to start going through my couch cushions to find extra money to invest.
Final thoughts
When I first started investing I was awed by some of the definitive statements I heard from investors. Some form of ‘despite the market continuing to sell off it was obviously cheap so I ignored the noise, invested every cent and made a fortune.”
All I could think about was learning enough to have that clarity of thought and certainty of action. I’ve come to realise it is all smoke and mirrors.
The market is only ‘obviously cheap’ with the hindsight of a subsequent market rally. Decision making in any endeavour is muddled by contradictory and missing data.
When I don’t have strong conviction I just stick to my plan. That is my default most of the time. This is one of those times.
It isn’t obvious to me that the market is cheap right now. I don’t think it is clear how this tariff mess will play out. I’m still buying each time I get a paid. I’m just not pushing all my chips into the centre of the table.
Spend some time thinking about your edge or competitive advantage over other investors. To do anything other than sticking to your plan right now means that you think you have an analytical edge.
An analytical edge is making better decisions using the same information available to everyone else. This is really hard to consistently do.
I believe that my biggest advantage as an investor is my behavioural edge. That means that the structure I’ve put around my decision making including defined goals and a set investment strategy are my advantage. That is what minimises my mistakes.
I will ‘buy the dip’ when there is a much larger margin of safety and more signs that other investors are being irrationally negative. I don’t think we are there yet.
I would love to hear your thoughts. Email me at mark.lamonica1@morningstar.com
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What i’ve been eating
This has been a trying week. I had my article ready to go and then I woke up Thursday morning and saw Trump’s backflip. It was back to the drawing board. On Thursday I wrote some diatribe comparing Roman Emperor Nero to a contemporary political leader – hint, it wasn’t Albo. That gave me a perfect segue into Greek food since Nero appreciated Greek culture. Anyway, my birthday is on Monday the 14th and Shani generously took me to Olympus in Surry Hills Village. The restaurant was packed and the food was great. Below is the Souvlakia Kotopoulo.
