Buy the Dips

By Dr. Duru written for One-Twenty

January 12, 2006

In a previous missive I noted how despite all the chop and sharp ups and downs, the NASDAQ has maintained an upward trend for the past 18 months. The S&P 500 has moved in a similar fashion albeit with less volatility. I care very little about the Dow because it is a price-weighted index and has little meaning in reality except as a marker of sentiment and psychology (thus, I have zero excitement over this battle for 11,000, and, in fact, I keep forgetting about it!). If we expand our view to the 2002 and 2003 bottoms, the signature characteristic of these markets has been to buy the dips. When the market has looked its worst, it has paid to dive in and buy. October, 2005 delivered our last period where all hope seemed lost. Each period like this has shaken out sellers and opened up fresh opportunities for bulls to make money. In particular, I never cease to be amazed when I pull up the charts of individual stocks and observe how fast the market's sentiment can change from absolute despair to incorrigible hope. Even a stodgy, cyclical stock like Caterpillar (CAT) has now returned 20% from its lows in October. Smaller and more speculative stocks have provided the daring with doubles, triples, and more on their money during this period. As with most runs of this nature, the bulk of the money was made in streaks: 4 weeks stretching from the end of October to November and the past week.

Of course no crystal ball exists to read and time bottoms in the market or stocks. But the lesson that keeps being handed to us is that the spoils have gone to those with conviction about themes or fundamentals. Even if such bulls bought every time the market has gone into despair, they have now come out far ahead of the game. Buying the dips works well in a bullish market and what we have had is a bullish market....even if it has been churning in fits for the past two years...even if the Fed has done its best at times to convince us that it was willing to risk a bear market to keep a lid on the economy.

The flip side of this streaky and choppy behavior has been that it has also paid to sell into euphoria; after all, much cheaper prices are coming around the corner. In other words, not only has an aggressive buying strategy been a winner, but an aggressive selling strategy has also done well. Again, you cannot expect to time the exact tops of the market, but if your habit has been to sell when the market has gotten extremely enthusiastic about the future, you have probably done well (of course, you have to buy during the times of despair to get this selling opportunity!) With the market stretching for infinity and boundless optimism again, you can bet that the sell signals are flashing like bombs bursting in air.

All of this insight is great with hindsight, right? I have not benefited from this behavior as much as I would have liked. During the last period of despair, I laid out reasons for buying right back into the oil and gas complex, and I pointed your nose to the international stocks (ETFs) and steel stocks. However, I missed a whole lot of opportunities like gold and countless tech and other speculative stocks. I also took a while believing in the resurgence of the housing stocks even when I reported on the evidence that was bubbling right in front of me. And worst of all, at the climax of despair, I chose to talk about the prospects for recession instead of doing a fresh review of the buying opportunities!

Now, past performance is no guarantee of future returns, so I am far from giving you a roadmap to riches by sticking with this on-going cycle of buying and selling. But I will contend that as long as the economy keeps trudging along at the current pace, this cyclical behavior of buying the dips and selling the euphoria should also continue to perform well. I see no catalyst that will send us into a bullish streak like the one we saw in 2003, so I stick to my contention that the decade will end with the markets making very little overall progress. But I do see a potential, imminent negative catalyst in the Fed disappointing the market by raising rates more and longer than the current euphoria assumes. In particular, note that even as the stock market ramps, we are getting ramps in all the instruments that typically give investors pause and cause for concern. Oil is streaking toward new highs and $70 a barrell. Oil continues to defy all those skeptics who persist in their claims that we will see $50 oil before $70 (heck, they are still waiting on $40 oil). The dollar is correcting even as long-term rates are turning up again (talk about a choppy trend!), and gold is responding with its own strong run. The renewed excitement in the homebuilder stocks has come even as these companies report more of the same and sometimes worse. The stock markets are even ignoring the growing risks of the bird flu...except when it comes to buying the stocks of drug and bio-tech companies that might benefit from a brutal about hubris! Eventually, the negatives will break through the current euphoria and open up a new opportunity to buy the dip. when we face despair all about us again, I will do my best to spend sufficient time reviewing the case for hope, even as I once again declare the bear has descended upon us!

(And for those of you with a sense of history, note that the last time I declared myself a "reformed bear", we had just gone through 10 months of a strong rally. We were also sitting on the first dip of many on the way to a strong climax of despair a whole six months later!) As always, be careful out there!

DrDuru, 2006