Should You Buy the Dip Is a Question Only You Can Answer
(Bloomberg Businessweek) -- 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% plunge during the week of Feb. 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% on March 2. 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 10-year Treasury yield slid at one point to a record of below 1%. (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 Feb. 21, the S&P 500 had a price gain of 393%. Against that, even an 11% 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-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 awhile: 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 such as 401(k)s who actively buy into the dip may actually be double-dipping. Since employees have money deducted from their paychecks and automatically moved into their 401(k) 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.
Retirement savers have been making an unusually high number of moves in their accounts lately. Trading activity in 401(k)s for the week of Feb. 24 made it among the busiest five-day periods in the 20-plus years that benefits administrator Alight Solutions has tracked such activity. Almost all of the recent activity was savers moving from equities to the relative safety of fixed income. Still, there was evidence of a buy-the-dip mentality: Savers made a slight increase to the equity allocation for their future 401(k) contributions.
Some financial advisers are fine with opportunistic buying as long as clients have enough cash set aside so they don’t run the risk of needing to sell stocks into a downturn. “When the market moved to a 10% correction point, the conversations with clients became ‘Are we going to be adding to equities?’ ” says Kerrie Debbs of Main Street Financial Solutions. Debbs says this additional buying generally only makes sense for retirees with enough safe assets to cover expenses for two to three years and for working people who can cover one to two years.
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% 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. “In times like this, you find out what a client’s real risk tolerance is.”
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.
Shifting some money into bonds can lower your volatility, but they aren’t obvious bargains in this market either. Investors in plain-vanilla bonds have been riding their own bull market: This year through March 3, Treasuries have returned about 5.8%, according to the Bloomberg Barclays US Treasury Index. If interest rates turn back up, bonds will fall in value. And for retirees and other investors who aim to buy debt and hold it to maturity, they’re locking in very low yields by buying now. That’s not to say bond prices can’t still rise or that yields can’t fall further: There’s more than $14 trillion worth of debt around the world with negative yields.
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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