Anticipating that the great bull market in stocks will charge on, investors are welcoming any transient decline in prices as an opportunity to increase their equity holdings, Bloomberg reports, asserting that "'Buy the dip' has never been so popular." In fact, "Investors no longer fear shocks but love them," concludes a research note released on Tuesday by Bank of America Merrill Lynch, a division of Bank of America Corp. (BAC), as quoted by Bloomberg.
Based on their analysis of trading activity in the S&P 500 Index (SPX) stocks, Merrill Lynch finds that "any early weakness in stocks is being met by an onslaught of buying" greater than at any other time from 2003 onwards, Bloomberg says. Merrill Lynch also finds similar recent patterns in stocks belonging to the Nikkei 225 Index and the Euro Stoxx 50 Index, indicating that widespread buying on the dip is occurring in these overseas markets as well, at near-record intensity, Bloomberg adds. (For more, see also: Buying Stocks 'On The Dip' Is the New 'Irrational Exuberance'.)
This buying frenzy comes despite repeated warnings that stock prices have advanced too far for too long without serious reversals, and that valuations are very high by historical standards. As of their last weekly calculated values on December 8, the forward P/E ratios on the S&P 500, the Dow Jones Industrial Average (DJIA), and the Nasdaq 100 Index (NDX) were, respectively, 20, 20 and 21, per The Wall Street Journal. From their lows on March 9, 2009 through the close on December 13, these three market barometers have risen by, respectively, 296%, 277% and 515%. (For more, see also: Investors Face 'Pain' in Highest Stock, Bond Values Since 1900.)
Meanwhile, the five so-called FAANG technology stocks have contributed roughly 5 percentage points to the 19% year-to-date rise in the S&P 500, given that they collectively account for nearly 11% of that capitalization-weighted index. An added risk is that, should the prices of the FAANGs falter for whatever reason, the negative impact on the S&P 500 may trigger a wider loss of investor confidence.
Causes for Overconfidence
Many investors have been lulled into a sense of overconfidence and complacency by the virtually straight upward climb of stock prices since those 2009 lows. In 2017, pullbacks have been modest, and quickly reversed. For example, a 1.8% drop in the S&P 500 on May 17 was completely erased just three trading sessions later, making this the swiftest recovery from a market decline of comparable magnitude since 1962, per Merrill Lynch's analysis as cited by Bloomberg.
Many investors also assume that central banks will step in to stabilize the securities markets in the event of a big selloff, Merrill Lynch adds, an assumption that may or may not be valid. Given that central bank programs of quantitative easing have pushed interest rates to historically low levels, near zero in some countries, this policy option already may have been exhausted to a large extent.
Watch Your Step
As one economist, investment advisor, and longtime financial columnist warns, blithely assuming that any given dip in the market may be a fleeting buying opportunity can be hazardous to your wealth. "That dip may be prove to be a chasm, and the rise beyond it may not make you whole," as A. Gary Shilling once wrote. In other words, it is impossible to tell whether what initially appears to be a momentary dip actually is the start of a deeper correction, or even the beginning of the next bear market. Investors who do not exercise sufficient caution and protect themselves may be in for a nasty fall. (For more, see also: Stocks: The 'Buy The Dip' Party May Be Over.)
Hedge Funds Are Buying
In addition to small individual investors, the so-called "smart money" also is eager to buy on the dips, according to James Helliwell, chief investment strategist and director of the Lex van Dam Trading Academy. In a commentary for Investopedia, Helliwell presents a checklist used by hedge fund managers and other professional traders that registers positive indicators for U.S. equities on five of six dimensions. (For more, see also: Hedge Funds See Opportunity in the S&P 500.)