On buying the dips and selling the bounces.


Listening to tennis commentators is mostly irritating. It’s not necessarily the level of detail they go into, but more like a sense of being constantly dragged through a theatrical performance where the real actors don’t seem to know they are being watched. Comments on completely invisible psychological or mind states of the players are the most ludicrous. (An exception is John McEnroe: straight, irreverently to the point, truly insightful and funny.)

In similar ways, various analysts and commentators, innocent bystanders, Nobel laureates and sundry chat-room specialists have recently fallen over themselves to recommend investors “stay the course”, “buy the dips”, “don’t panic”, “don’t sell”, “don’t…” basically anything. It’s as if all this talk of a correction-less period has made us hypersensitive to a routine downdraft: how else to explain the excitement over a 10% decline (on the S&P 500)? A buying “opportunity”? Give us a break.

These recommendations are not necessarily wrong but they must be viewed in the context of current market conditions and investor’s objectives. Abrupt changes in the environment can be the warning sign to significantly more meaningful breaks in market behavior. Instead, most times “experts” find it easier to opine in the direction of the recent trend. If the market has gone up for a considerable period of time, they inevitably come out in favor of buying on dips, whereas if the trend has been negative the uniform call is for selling the bounces. Doesn’t it occur to anyone that logic – all else being equal – should suggest the opposite?

Think about it this way:

– After a substantial rally over several years, and with diminishing volatility, we run into elevated turbulence. While investors are awakened from total complacency, the tendency is to interpret the shocks as temporary aberrations and to look for entry points to buy or “put money to work” (presumably while the sellers are “putting money to sleep”). This is backwards: higher prices not associated with higher earnings growth over several market cycles imply lower future returns. This means higher risk of loss.

– When eventually – as all market cycles have an “up” and a “down” leg – we find ourselves in the middle of a market rout, investors will similarly tend to sell every rally (money does need to sleep after all). in this way they crystallize losses of capital and hamper chances of recovery. It does not occur to most that a radical decrease in prices without a corresponding decline in earnings growth over multiple cycles implies higher future returns, nor that risk now is lower than before.

In financial decision making it seems we are hardwired to do a lot of things that are not logical nor particularly safe (see Howard Marks’ last investor letter). As if evolution of everything but our “money-mind” just went too far too fast for us. A little patience could go a long way in these cases, just like you can’t miss vacations if you live permanently in one.