“Buying on the dip” has been a rewarding and reliable strategy during the recent bull market, however UBS analysts are warning traders that now is the time to put the dipper down.
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Following a healthy spike on Tuesday, stocks drastically dropped the next day, erasing the gains from the day before and sparking fears of a recession that will likely render the dip not worth buying.
“A world where leading indicators are accelerating is generally one where a correction in equities is an opportunity for investors and ‘buying the dip’ gets rewarded. In contrast, today’s backdrop with PMIs [purchasing managers indexes] in the low 50s and rates arguing for further declines often results in buying the dip being a losing proposition,” strategists Francois Trahan and Samuel Blackman said in a statement obtained by MarketWatch.
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PMIs measure private-sector business activity, with the Institute for Supply Management’s readings used to help predict economic prospects.
The specter of recession loomed Wednesday after the Dow Jones Industrial Average dropped around 800 points, at a loss of 3 percent, while the S&P 500 fell 2.9 percent following an inversion of the yield curve, which is measured by both 10-year and 2-year Treasury yields.
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Trahan and Blackman assert that going back to 1974, throughout the past nine full economic cycles, “buying the dip” is most effective when PMIs are accelerating, in what analysts call “risk-on” period. In fact, “dip buying” has nearly a perfect record during that “risk-on” phase, but not so much during the “risk-off” phase, where the performance of “buying the dip” is mixed at best.
When PMIs dip below 50, in what’s known as a “risk aversion” phase, “dip buying” rarely pays off, according to market analysts. A PMI reading above 50 suggests that economic activity is expanding, while a reading below 50 signals contraction.
“The market has been volatile although we should keep two things in mind,” said Fox Business Network contributer Charles Payne of the market’s recent unstability. “Its held at key support even as its failed at key resistance. I think it will trade wildy in this range until there is greater clarity on trade (Wall Street came to the conclusion long ago a resolution was a long ways off) and better understand how far the Fed will go to keep the economic expansion going. Both those could be answered during month of September.”
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Following an 18-month lag in interest rate yields, Trahan and Blackman warn “the path laid by interest rates 18 months prior to today shows that there is now tightening in the pipeline, and it’s more likely we experience multiple contraction than expansion in the months ahead.”
With a “risk-off,” contraction phase now entering into effect, “dip buying” may not be entirely advisable. In fact, analysts claim the risk/reward for “buying the dip” under the current conditions is “extremely poor.”
