US Economy

  • 25 Jun
    “Buy the Dip” is a terrific, time-proven bullish strategy – has its time passed?

    “Buy the Dip” is a terrific, time-proven bullish strategy – has its time passed?

    No matter whether we look at the market and economy with a short or long-term perspective, and no matter what method we usually use to make money in our investments, as investors we are all limited by our inability to see the future. Since we can’t see or know what’s going to happen, we’re left to do our best at making semi-educated guesses using imperfect information. That also means relying on historical data to make forward-looking decisions like what to do with our money. We assume that because a certain method, strategy, or technique worked under certain conditions in the past, it should work again now, or in the future when conditions appear similar.

    There are a lot of investing techniques and strategies out there, and a lot of the most popular ones use a really catchy turn of phrase so you can remember them easily. “The trend is your friend” is one that I learned early in my investing career to help me determine which direction, bullish or bearish, my trades should generally be taking. Another one that has been really popular for the last few years is “buy the dip.” This is one that worked out really well for short-term traders all the way through 2016 and 2017. Here’s what I mean. The chart below is for the SPY, which is an exchange-traded-fund (ETF) that tracks the movement of the &P 500 index.

     

    The green diagonal is a good reference for the market’s long-term trend line during the two-year period shown here. “Buy the dip” means that whenever the stock market experiences a short-term drop – how much really depends on the individual’s preference, and can be a percentage from the last high, a total number, or a visual reference such as the one I’m using here – it’s really an opportunity to buy in and ride the next wave higher. If you’re a short-term trader, using a trend line like the one I’ve drawn would have provided an excellent reference point. I’ve highlighted four difference points over the last two years where a drop to or near to the trend line provided a really good entry point for a bullish trade. While you can’t buy the index, you can trade options on it, or you can work with an ETF like the SPY to go long on the stock or to use call options at a lower cost than index options would carry. If you buy on these kinds of dips, you would hold for as long as the market is showing solid bullish momentum, and then sell when you see the next short-term dip. Taking that approach on any of these four entry points would have generated excellent profits.



    Another approach that really became popular during this period is what you’ve probably heard called “passive investing.” It also relies on the same kind of signals for an entry, but then suggests that since the market is going to experience the same kind of short-term ebbs and flows, all you really need to do is find the next entry point and then ride the next several waves higher. If you were fortunate enough to get in on the dip in July 2016, around $201 and then followed the passive investing mindset, by the end of 2017 you would have been looking at almost $70 per share in profit from the SPY. That’s a two-year return of almost 34%! It’s really no wonder that so many people gravitated to passive investing using ETFs or stock index mutual funds like the Vanguard 500 Index Fund during this time; it really seemed like the market was a no-brainer, can’t-miss kind of investment.

    The problem that underlies methods like passive investing, or even the normal “buy the dip” mentality is that most investors lose the discipline to pay attention to signals that the market is changing. It usually means they just assume the upward run will never end, and the latest drop is just another “dip” in the latest series of dips before it picks up again. That puts the average investor at big risk when the broad market experiences the kind of rare, “sea change” shifts that only come along once or twice a decade. The last economic cycle that ended in a recession in 2008 is a perfect example.

    As with the last chart, I’m using the green diagonal for the market’s long-term trend from late 2002 through the beginning of 2008. The blue circles highlight terrific “buy the dip” points that had a lot of people thinking the market was just going to keep going up forever. The red circle highlights a dip in the latter part of 2007 that by all appearances looked like just another dip in the longer trend, but really proved to be just the last desperate gasp of momentum the market had left. At the beginning of 2008, the SPY dropped below its long-term trend line and found a temporary bottom around $132 per share. That’s about a 9% drop from the entry around $145 that most “buy the dip” traders were taking in late 2007, and should have been a clear signal to exit the trade and cut your losses. If you didn’t recognize that signal, your loss could have been much, much bigger since the market didn’t find a bottom until early 2009, when the SPY was around $67 per share. That’s a drop of nearly 54% if you rode it all the way to bottom, and didn’t get reclaimed until late 2012. That’s the kind of loss, and extended, protracted recovery that most traders that love to “buy the dip” when the times are good can’t handle.



    One of the big keys to being successful with any investing strategy, no matter whether it works on a short-term basis or with a long-term perspective is really less about when you buy a stock than it is about when you sell. Smart “buy the dip” investors will usually sell when they see the market staging short-term weakness that could become a longer-term downward slide. That locks in their profits and opens up the opportunity to buy in again on that next dip, hopefully at a low point. Acting quickly on taking profits also would have the advantage of getting you out of the market before a “last gasp” rally turns into a market reversal.

    The danger remains, however that could buy a dip expecting just another upward thrust, but ultimately see the market reverse right after you got in. That’s why it’s also important to pay attention to trends and recognize that when the market drops below major, long-term trend lines, the risk of a “sea change” reversal is incrementally higher than normal. If you bought the last dip in late 2007, for example, it would have been much better to recognize the drop below $140 for what it was. Even if you didn’t get out until the market found a temporary support point around $132, an 8% loss on that trade would have been far easier to deal with than riding the SPY all the way down to $67 hoping for an eventual turnaround.



    Okay, now let’s take all of that and talk about what the market is doing now. As of this writing, the market is down about 3% from its last high about two weeks ago. Is that just another “dip” that investors should treat as a buying opportunity, or maybe something more serious. Let’s take a look.

    The green diagonal line is, once again our proxy for the market’s long-term trend, with the dotted blue line acting as visual reference for its short-term trend. “Buying the dip” would have been really profitable if you bought in April, and dips in the early part of May, and then again late that month would have also have yielded some decent short-term gains. Notice that the index has dropped below that short-term trend line as of today. If it turns back to the upside, that could be another good short-term signal, but it also should be taken as a warning sign that it’s time to be a little bit cautious. Are we looking for a major, “sea change” kind of reversal? Not yet; but it’s also true that the index is just a short distance – less than 5%, in fact – away from the long-term trend line. A drop below $260 per share in the SPY is exactly the kind of signal that “buying the dip” is going to put you at an increasing risk of being on the wrong side of the market, at exactly the wrong time.

    What if the market proves the naysayers wrong yet again? The problem with the long-term trend right now is that the market’s activity since late January has forced that trend to flatten out, meaning that it is losing momentum and strength. Short-term traders who recognize this reality won’t necessarily stop trading, but they will usually act even more quickly than normal to close out winning trades and lock in profits than they might be to let their winners run. The fact is that until the market moves past its all-time high, reached in late January when the SPY peaked at almost $287 per share, it’s hard to make any kind of substantive case for any kind of continued bullish rally that would extend this bull market past its current nine-year run and possibly into the next decade.


  • 28 May
    This Stock Is A Canary In A Coal Mine For The Economy & You Should Be Paying Attention

    This Stock Is A Canary In A Coal Mine For The Economy & You Should Be Paying Attention

    History tells us that when the FED starts to raise interest rates, sooner or later the economy will be hit.

    Today, we’ll discuss what’s going on with rates and the economy, and where we are in the current economic cycle in order to determine portfolio risk exposures.



    The Relationship Between Interest Rates & The Economy

    If we take a look at the chart below representing the effective federal funds rate, we can see that usually but not always, a tightening period is followed by a recession depicted by the grey columns. More →

  • 15 May
    Are We In Another Real Estate Bubble?

    Are We In Another Real Estate Bubble?

    • The data resembles 2007, but there are other factors to think about.

    Introduction

    Recently, I was listening to an interview with Robert Shiller where he was explaining how they predicted the 2000s housing bubble. This got me thinking so I went to dig deeper and found the following chart.




    More →

  • 14 May
    Can You Hear The Economic Warning Bells Ringing?

    Can You Hear The Economic Warning Bells Ringing?

    A quick investment perspective on the current economic news will give us insight into what to do with our portfolio, what the best risk reward portfolio allocation is at this point in time, and what one can expect to happen.

    I’ll look at U.S. economic data, emerging market yields, and touch on Italy which is becoming a bigger and bigger risk.



    Economic Data – Strong, But Also Weak

    The headline consumer price index came in at 2.5% which is good, but might lead to higher interest rates which is a dance that has to stop at some point. More →

  • 25 Apr
    Here’s Why You Should Worry About What Happened In The Market Yesterday

    Here’s Why You Should Worry About What Happened In The Market Yesterday

    The thing with the stock market is that it gives you signals way ahead of time, but nobody wants to listen. The things I’ve been blabbering about over the past two years are the following:

    1. Higher interest rates will come just as the FED told us they would.
    2. Higher interest rates will squeeze valuations.
    3. Higher interest rates will slow down economic growth.
    4. Higher interest rates will slow down earnings growth.

    So, let’s start by discussing these.



    The 10-Year Treasury Passes 3%

    When the 10-year Treasury was below 3%, nobody seemed to care except a few crazy analysts like this scribe. However, when it crossed 3%, the market suddenly looked at what had been going on for nearly the last two years. More →

  • 23 Apr
    This Market Is Getting Crazy – Here’s How Buffett Says To Invest In It

    This Market Is Getting Crazy – Here’s How Buffett Says To Invest In It

    • We’ll discuss some news first, including commodity prices, chip guidance, and covenant ratios.
    • Then we’ll put things into perspective and see what an investor can do in this market.
    • I’ll give you a few tools that will make investing easy for you, if you can handle them.



    Introduction

    Last week, the stock market was positive for half of the week and then negative for the remainder. More →

  • 18 Apr
    These 4 Steps Will Save You In The Upcoming Market Crash

    These 4 Steps Will Save You In The Upcoming Market Crash

    A stock market crash is always around the corner.

    In the last 18 years, we’ve seen two crashes of 50% and if you live in the Netherlands, you still dream of those 2000 highs. Nevertheless, a 9-year bull market quickly erases all the painful memories.

    But forgetting what happened and how it looked is dangerous. If you haven’t lived through a stock market crash, you should at least try and think about it in order to be prepared as much as you can be.



    More →

  • 17 Apr
    The Flattening Yield Curve Means Trouble Ahead. Here’s What You Need To Know.

    The Flattening Yield Curve Means Trouble Ahead. Here’s What You Need To Know.

    • What is the yield curve?
    • The yield curve is flattening and if it inverts, there will be a recession.
    • What you can do.



    Introduction

    In this article, I’m going to explain what the yield curve is, what a flattening or steepening yield curve means, how the yield curve impacts the economy, and see whether the current yield curve indicates that we are close to a recession in 2018. More →

  • 09 Apr
    These Will Be The Causes Of The Next Recession

    These Will Be The Causes Of The Next Recession

    After a long period of stillness, we are finally seeing two-way markets which is a clear indication that the market is looking for direction.



    Last week we saw two days with drops larger than 2%, and the so called Kudlow rally on Wednesday. More →

  • 04 Apr
    This Is Why The Stock Market Is Crashing

    This Is Why The Stock Market Is Crashing

    • I’ll discuss the short-term perspective on what is going on, and the long term.



    Introduction

    I’ve been writing about the risk the stock market carries forever now. However, nothing was really happening until the last two months when volatility spiked and stocks actually went below their all-time highs. More →

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