This guest commentary was written by Peter Atwater of Financial Insyghts

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Every market cycle offers something new. The late 1990’s brought us internet stocks and day trading. 10 years ago there were NINJA loans and CDOs as Wall Street sliced and diced residential mortgages like never before.

The current post-banking crisis cycle has fostered crypto-currencies, FANG stocks, ETFs on steroids and a tsunami wave of passive investing. It has also brought us the acronym BTD (“Buy The Dip”), and its more adamant, if not more vulgar, derivative, "BTFD.” (And, yes, the F-word rhymes with trucking.)

Rather than fearing declines in price, pullbacks are to be fully embraced – an extraordinary opportunity to buy into a specific stock or the market more broadly at a discount.

Investors Shouldn't Be Piling In

While this behavior may seem intuitive, particularly to non-investors, this isn’t how market prices and confidence have historically correlated. More typically, confidence and market prices have been positively related, with falling prices suggesting mounting fear among investors, and with rising prices suggesting the reverse. At lows in price – think after 9/11, for example – investors should be afraid to buy. They shouldn’t be piling in.

Thinking back over the past eight years, I can think of only two moments of meaningful stock market fearfulness. The first was back in October 2011 – when this was the cover of The Economist.

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The second was the evening of Election Day, when it became clear that Donald Trump would defeat Hillary Clinton, and the futures market collapsed. While unnoticed by most investors, there was panic.

Beyond those two events, though, the post-banking crisis stock market declines have been remarkably tame. Not only has there been limited fear, but because fear has been tempered, the price declines have been minor.

In Saturday’s Barron's, columnist Randall Forsyth commented on this, noting:

“[T]he stock market has gone a long stretch without approaching anything resembling a correction; it has been a year since there has been so much as a 5% pullback in the S&P 500, according to Ryan Detrick, senior market strategist at LPL Financial. It’s only the sixth time since 1950 that the S&P has gone 12 months without a 5% dip, and it’s the longest period without such a shallow decline since 1995."

Writing in his blog over the weekend, trader Tony Caldaro went one step further, sharing:

“After a microscopic 2% correction in the SPX, 4% correction in the NAZ, and no correction in the DOW, the SPX/DOW made new all-time highs on Friday. We checked back to 1982, and could not find a SPX correction this small in a bull market.   Quite unusual correctional activity lately.”

What caught my attention – and what prompted this blog post – though, was this Wall Street Journal article from Ben Eisen that appeared just two days after retailing stocks appeared to make a major low on Tuesday.

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Rather than fear following a 25% drop in retailer shares – with many individual names all but decimated – there was almost giddiness. To believe the people interviewed by Mr. Eisen, now is the time to back up the truck and pile back in!!

To give you a sense for how extreme current thinking is, Mr. Eisen wrote a comparable story about investors piling back into energy stocks in May last year – three months from the low!

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When I saw Mr. Eisen’s first article I was worried that the bounce in oil was flaming out quickly. With his article this week, I am now gravely concerned about the stock market. Complacency has reached such an extreme – and the response to lower market prices has become so Pavlovian – that investors aren’t waiting for stocks to even decline before they are buying the dip.

Buying the Dip is a Pavlovian Impulse

To be clear, it isn’t just in stocks where this Pavlovian market response is now evident. The same has become true in the credit markets and private equity, as well. Today we buy the dip, lend the dip, and flood the dip with money however we can. That there are now articles referencing “death by overfunding” (herehere and here, for example) speaks to the current systemic craziness of it all.

While each investment cycle brings a different means of making money, the end is always behaviorally the same: At the peak in confidence, investors are fearless.

That we now have “dip-less” markets flooded with capital suggests that is precisely where are today.  To borrow from the Economist cover above, now is the time to "Be Afraid."


This is a Hedgeye Guest Contributor note written by Peter Atwater, founder and president of Financial Insyghts. He previously ran JPMorgan’s asset-backed securities business. He is also the author of the book Moods and Markets (FT Press, 2012) which details how investors can improve returns by using non-market indicators of confidence. This piece does not necessarily reflect the opinion of Hedgeye.