Don't Call It A Dip!

Barry Ritholtz was on Bloomberg for what I think is his weekly appearance and today's conversation focused on whether or not to buy pullbacks or BTFD if you know that acronym and a couple of other things. 

On buying the dip, I both agree and disagree with what Barry said. He said it is very difficult to time the bottom on theses declines that come along, very few people can do he said. I agree with that idea, it is difficult to reliably bottom tick a decline. Enough tries and yeah, you'll do it a couple of times but that is not a reliable methodology.

I do disagree with the framing of the entire premise. I would say forget about trying to guess when bottoms are in, don't think of it in those terms at all. A long time ago I said something like the odds of a large decline are a lot less after a large decline. When we're in the middle of a 20% or 30% or 50% decline, and of course on the way down there's no way to know where it will stop, you have a chance to buy at a very good discount. It's a good discount, it will still be a good discount even if it goes lower before going higher.

The habit of adding to equity exposure after a 30% decline is very likely to have a very good long term outcome, even if you're "wrong" for the next six months meaning it goes on to bottom at a 50% decline. Peter Lynch is instructive here, "I don't know what direction the next 20% is but I know what direction the next 100% is." The S&P 500 closed today at 4225. In 2007 it peaked at 1530. If you added to equities after the first 30% down, or 1071, does it today look like a good decision? The timing was not very good in the short term but handsomely rewarded nonetheless. 

If the current decline turns into something more serious and you can buy more down 30%, how good will that decision be 10 years from now? Pretty good I'd venture even if down 30% is just a stop on the way down to 40% or 50%. 

In Barry's appearance, Lisa Abramowitz asked Barry if his firm was doing anything different, if they were sitting on more cash than normal and he said no they weren't. I got the impression that they normally don't have much cash in client accounts but I don't know. What I will say is that I'm a big believer in setting cash aside for clients who are taking income from their portfolios. No matter where this current move down bottoms out, we know what will happen. The market will stop going down at some point and then eventually it will make a new high. We just don't know how long that will take.

Once someone really accepts that as true then they stop worrying about the market and start to turn their attention to making sure their portfolio income stream is not disrupted. The way I do things, that can mean having cash set aside or selling hedges owned for clients that are meant to go up when the market goes down. The need to hedge against a large decline is much less after a large decline.