Is This Why BTFD No Longer Works

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One week ago, Bank of America said that its “buy-the-dip” trading rule (first introduced in 2016 and designed to demonstrate how unusually fast markets were rebounding from selloffs) was triggered for the second time this year as the S&P declined more than 5% from its previous 10-day intraday high.

Yet to those BofA clients who followed the bank’s advice and loaded up after the August 5 plunge, the jury is still out: even with today’s sharp move higher, investors are barely breaking even, and that assumes that they held on after Wednesday’s rollercoaster plunge which sent the S&P 3% lower, and got president Trump to call the big 3 bank CEOs, for an explanation why stocks were dropping so fast (in response to his trade war).

One possible reason why what was once the most sure way to make money on Wall Street – namely Buying the Dip – no longer works, is because as Morgan Stanley noted last October, BTFD died in 2018.

But why? We now have the answer thanks to an analysis from UBS.

In a note from the bank’s strategists Francois Trahan and Samuel Blackman, the UBS duo argue that “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.” However, and in contrast to a generally rosy economic environment, “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.”

Specifically, when looking at history over the last nine full economic cycles going back to 1974, Trahan and Blackman find that buy-the-dip works the best when leading economic indicators, like PMIs, are accelerating.  Indeed, during that period of either recovering or accelerating PMIs, called by UBS the “risk-on” phase, buying-the-dip had an almost perfect record with the S&P up 27 out of 27 times.

Howewer, after the readings peak and the ensuing “risk-off” phase, the performance is mixed, with BTD working less than half the time, or 4 out 9, when PMIs are approaching the contraction phase. And when PMIs dip below 50, marking the “risk-aversion” phase, dip-buying truly dies, leading to profit just 1 out of 9 occasions.

This is shown in the chart below.

Of course, as readers are well aware, the two latest mfg ISM prints have hugged the 50-line, and represent the gray zone where the S&P is up only 4 out of 9 times after a sharp dip.

There is more to the BTD analysis, and it goes beyond just determining the phase of the PMI cycle. As the two analysts point out, the ideal risk-reward scenario is when the “risk-on” PMI phase is also accompanied by interest rates that are supportive of PE expansion and the earnings outlook is favorable, which as we discussed earlier is certainly not the case now that the S&P is effectively in an earnings recession. In fact, right now would-be dip buyers are 0-for-3, according to UBS.

As for interest rates, while one can argue that record low rates are supportive of risk, the analysts look at yields with an 18-month lag. As a result, “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,” the UBS duo wrote.

In conclusion, the UBS echo Morgan Stanley and warn that the risk/reward for buying the dip at the present moment is “extremely poor.”