Buying On Dips Is Good But This Time Investors Got Burned

As long as the bull market continues, buying on the dips will be a winning strategy that allows investors to take advantage of temporary bargains. The problem is, no one can forecast with certainty whether the next dip is a just fleeting downtick in stock prices, or whether it's actually the start of a protracted correction that sends the market down by at least 10%, if not the opening act of a bear market that slashes prices by 20% or more. 

Nonetheless, a number of prominent investors and investment strategists have been predicting a "melt-up" in stock prices, The Wall Street Journal reports. According to this school of thought, per the Journal, the strongest upward surge in stock prices often occurs near the end of a bull market cycle.

Among the proponents of this viewpoint is famed investor Jeremy Grantham, who wrote early in January that he expected a sharp melt-up in stock prices lasting from six months to two years, followed by a sharp decline, the Journal adds. Fundamental factors that add to these rosy expectations are strong worldwide economic growth and rising corporate profits, with profit increases in the U.S. accelerated by tax reform.

Recent Losses

From its record close on January 26, the S&P 500 Index (SPX) retreated 6.2% through the close on February 6. During the same period, the Dow Jones Industrial Average (DJIA) also fell from an all-time record, declining by 6.4%. While these indices posted gains on Tuesday that recouped some of their big losses on Monday, it is still much too early to say if the recent selloff has run its course.

Some Dow components have done even worse than the market averages in this time period, such as: Chevron Corp. (CVX), down 11.0%; Exxon Mobil Corp. (XOM), down 11.9%; Johnson & Johnson (JNJ), down 9.4%; Intel Corp. (INTC), down 7.3%; and 3M Co. (MMM), down 8.6%.

No Sure Bets

As noted above, buying on the dip comes with no guarantees that a rebound in price will occur anytime soon, whether for market indices or for individual stocks. Regarding the five stocks mentioned above, the fact that their prices fell more than the Dow or the S&P 500 suggests that other company-specific or industry-specific factors were in play.

Rather than blindly scooping up stocks that have fallen the most, the wise investor would do well to explore the fundamentals behind each stock, lest they buy into longer-term declines. (For more, see also: Buying Stocks 'On The Dip' Is the New 'Irrational Exuberance'.)

The Return of Volatility

The recent downturn in stock prices has been accompanied by a sharp increase in market volatility, as measured by the CBOE Volatility Index (VIX). Betting on a continuation of the abnormally low volatility that marked most of 2017, speculators have engaged in risky bets that it would continue, as described in another Journal article. This supposedly sure bet called the "short-vol" trade has unwound with a vengeance since January 26, and with particular vehemence during the sharp selloff on Monday.

"Two years of huge gains of as much as 800% in these products [futures and options tied to the VIX] have turned to catastrophic and even total losses in just two weeks," as Blaze Tankersley, a partner at trading firm ThreeFive Global Analytics told the Journal. (For more, see also: 6 Forces That May Push the Stock Market Even Lower.)

Lesson number one: there is no such thing as a sure thing in investing. Lesson number two: investing strategies can unravel at some point. Lesson number three: no one can predict the future with certainty. Investors need to remember these truisms whether engaged in strategies as new as the "short-vol" trade, or as old as buying the dips.

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