Still Waiting for the Dips
In a bull market, “buying the dips” is a classic strategy: You wait for a pullback of at least 10% in prices, then you put money to work. It often beats chasing sudden hot streaks that can result in overpaying -- or worse, buying at the top.
But what if the dips are so short-lived and modest, you barely have time to react before the market is up again?
That has been a problem for many cautiously optimistic stock investors during the last year. On Wall Street, the normal “correction,” or periodic decline of 10% to 15% in major market indexes, has been a no-show.
The blue-chip Standard & Poor’s 500 index had two pullbacks last year that were little more than blips. The worst was a drop of 7.2% between March 7 and April 20.
In fact, the S&P; 500 hasn’t suffered a decline of 10% or more in nearly three years. That’s about as long as the current bull market has been going on.
Over the last year, sell-offs also have been muted in indexes that usually experience far more volatility than the S&P; 500, including the Nasdaq composite index, the Russell 2,000 small-stock index and some gauges of foreign stocks.
Merrill Lynch & Co.’s emerging-market strategist, Michael Hartnett, on Jan. 30 sent clients a report listing 10 good reasons that stock prices in countries such as Russia, Brazil and Turkey were due for a 10% haircut after their phenomenal gains of recent months.
We’re still waiting: The Fidelity Emerging Markets fund has slipped just 2.7% since reaching a record high Feb. 1.
And from the looks of the cash pouring into emerging-market shares in general, investors don’t care to wait for more of a discount. A total of $3.3 billion flowed into U.S. funds that invest in those markets in the week ended Wednesday, the most in at least a decade, according to data tracker Emerging Portfolio Fund Research in Cambridge, Mass.
All of this is frustrating for long-term investors who want to put more money into stocks, but would prefer to do so at somewhat cheaper prices. In most bull markets, corrections come standard.
Consider that during the roaring market advance of 1995-1999 there were five pullbacks of 10% or greater in the S&P; index: one each in 1996, 1998 and 1999, and two in 1997, according to research by Michael Panzner, a veteran stock trader at Rabo Securities in New York.
Of course, once a decline begins, it’s only apparent in retrospect whether it is a correction in a continuing bull market or the start of something much worse.
Buying the dips in technology stocks in 2000 was a disastrous strategy; few investors could have imagined that the Nasdaq index was on its way to losing 78% of its value by October 2002.
The bullish view of the recent lack of broad market hiccups is that it’s a sign of the underlying strength of the advance.
Plenty of individual stocks have had wide swings in the last year on good or bad news specific to them. But the absence of classic corrections in the market overall suggests that few investors are bolting for the exits on general bad news -- say, the London terrorist bombings last July, or September’s hurricanes -- and that it doesn’t take much of a drop in share prices to entice buyers to come in.
Those explanations hold some water, but they aren’t the whole story, many Wall Street pros say.
One force that is keeping broad indexes like the S&P; 500 levitated is sector rotation, meaning that money is moving out of some stock industry groups and into others.
As major drug stocks in the S&P; declined in 2004 and 2005, for example, energy stocks in the index took up the slack, and then some.
The net result of sector rotation within the S&P; has been a fairly dull showing for the index itself, despite plenty of action underneath. The S&P; gained 4.9% last year, including dividends, as winning stocks in the index just modestly offset the losers.
Rotation eventually happens in all bull markets, but this time there is a twist: the boom in exchange-traded funds, or ETFs -- stock portfolios that offer an easy, cheap and effective way to quickly get into or out of individual market sectors.
ETF assets now total $300 billion, up from $100 billion at the end of 2002, according to the Investment Company Institute. There are more than 200 individual ETFs, tracking every major industry group and foreign market.
Marc Pado, U.S. strategist for brokerage firm Cantor Fitzgerald, suggests that the popularity of sector ETFs has meant less pressure on the broad market, up or down. Instead of buying or selling an S&P; 500 index fund, investors can play just the sectors they want, he says.
That may be helping some stock sectors, and emerging markets, avoid big corrections, at least so far. Mexico’s bull market, for example, has gotten an assist from the iShares Mexico Index ETF, a U.S.-based fund that has 13.7 million shares outstanding, up from 3.8 million at the end of 2003. The fund now holds $500 million of Mexican stocks, compared with $65 million at the end of ’03.
For U.S. blue-chip stocks, another volatility-damping force is the surging use of put and call option contracts, says Bernie Schaeffer, head of Schaeffer’s Investment Research in Cincinnati and an expert on options.
Options provide a low-cost way for investors to make bets on individual stocks and market indexes or to hedge against declines.
The contracts have never been more popular. Option trading on the Chicago Board Options Exchange, the world’s largest options market, hit a record 53.9 million contracts in January. That was up 54% from a year earlier and up 144% from January 2003.
Options are heavily used in trading strategies involving big-name stocks. Over the last year, that has helped to assure that any rallies or sell-offs in the S&P; 500 haven’t had legs, Schaeffer says: Soon after a broad buying wave begins, it dims because of selling fueled by option-related strategies designed to capture a quick profit, he says. Selling waves likewise dissipate quickly.
“You get these hurry-up-and-wait rallies and hurry-up-and-wait declines, and neither results in anything much,” Schaeffer says.
Some investors might figure this market is exactly what the doctor ordered after the wrenching decline of 2000-02. What’s wrong with a slow-moving advance in the S&P; 500?
Would-be buyers might like a 10% to 15% drop to make stocks cheaper, but the index’s unwillingness to accommodate them could just be a sign that share prices aren’t overvalued at these levels.
Still, it would be silly to believe that market corrections have gone the way of the dinosaurs. At some point, Schaeffer says, something will happen that will “punch holes in the notion that this low-volatility environment is going to continue forever.”
If that something is bad news, the question is whether we then get a standard correction, or whether stocks head directly into a new bear market, meaning a drop of 20% or more in indexes such as the S&P; 500. (True long-term investors might relish as big a decline as Wall Street is willing to give them. How many people now wish they’d bought stocks in 2003?)
In the meantime, caution isn’t a bad thing in the fourth year of a bull market, Schaeffer says. He recommends holding as much as 25% of your portfolio in cash, waiting for better share prices particularly in smaller stocks and foreign issues.
The key is to make sure that, if you’re waiting for a pullback to put money to work, you do exactly that when prices finally go your way, assuming that the stocks you want haven’t lost their long-term appeal.
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Tom Petruno can be reached at tom.petruno@latimes.com. For recent columns on the Web, visit: www.latimes.com/petruno.
