Way back in April, two months after investors too young to remember a time when two-way price action was a thing learned the hard way that stocks sometimes go down as well as up, BofAML floated a heretical theory: “Buy the dip” was failing.
“In 2017, we showed how a simple trading strategy of holding cash and buying any 5% dip in S&P futures until either the market retraced or 20 trading days passed outperformed the S&P on a risk-adjusted basis consistently since 2014”, the bank wrote, in a highly amusing note that quantified the extent to which “BTFD” had morphed from a derisive meme about retail investors into a viable (indeed, an almost infallible) trading “strategy”.
How was “BTFD” legitimized? How did it come to be that “BTFD” went from being a standing joke to a real thing? We’ve been over this before, so if some of it sounds familiar, it’s because this is familiar territory.
The vaunted “Goldilocks” narrative of synchronous global growth and still-subdued inflation underpinned the low vol. regime by allowing traders to point to upbeat economic indicators while citing well-anchored inflation as a reason to expect central banks to remain accommodative for the foreseeable future.
And when it came to central banks, the two-way communication loop between policymakers and markets became a self-fulfilling prophecy. Markets became so conditioned to policymaker intervention and dovish forward guidance that no one saw any utility in waiting around for it anymore. After all, if you know it’s coming, why wait on it? Why not buy the dip now?
Once that mentality takes hold, it obviates the need for further dovishness. Markets react to the expectation of dovishness and in doing so, ensure that the policymaker “put” runs on autopilot. As BofAML put it, “competition to buy the dip becomes so strong, CBs no longer need to react.”
Well, in February, that entire dynamic started to falter. Here is the chart which illustrated how things used to work, and how, through early April anyway, the strategy looked to be losing its appeal.
Over there on the right-hand side, you can see that “buy-the-dip” had seemingly stopped working. BofAML went on to provide further details along with some additional visuals. To wit:
The 5-Feb-2018 trigger seems most similar to the 21-Aug-2015 shock (China slowdown scare), which lost 1.93% upon liquidation at the end of the 20 trading day window and ultimately took 52 days to fully recover (Chart 8 and Chart 9). Looking at the recent 5-Feb shock, we are 43 days in and the market is down an additional 1.63%. However, in comparison, after 43 days into the Aug-15 shock the S&P had actually recovered about 2%. While in ‘15 Chair Yellen supported markets by announcing a delay of rate hikes due to concerns about China and equity weakness, today few expect Chair Powell to step in to support stocks. Our trading rule triggered for a second time in 2018 on 22-Mar, and as of 6-Apr we are 13 days into the 20 day investment window. At current prices, the trade has lost 2.13%. In order for the dip to fully recover within the window, S&P E-mini futures (ES1) would need to cross 2,802.50 by 19-Apr, over 7% above 6-Apr’s closing level of 2,605.75.
Needless to say, investors’ faith in BTD was subsequently restored. Just over four months after BofAML wrote the passages cited above, the S&P summited new peaks and everything was “right” in the world.
Well, actually, that’s only true if you define “world” as “U.S. equities.” Ironically, everything was “wrong” in the literal “world” at that juncture, because just as U.S. stocks hit new highs in late August, EM was in the midst of an egregious currency rout and the divergence between U.S. stocks and everything else had reached unprecedented levels.
Fast forward to November and the Nasdaq is some 15% off its highs. There’s blood on the streets. The barbarians are at the gates.
Enter Mike Wilson.
Wait, who is Mike Wilson?
You remember Mike. Mike is the nice man at Morgan Stanley who, in a Sunday note to clients on July 8, gently suggested that Tech and Growth were about to “get wet.” Here is the quote from that piece:
Similarly, we think the risk is rising that US tech and growth stocks will get wet. While we are not worried about an economic recession as the catalyst for underperformance in these market leaders like it was back in early 2016, we do think that 2Q earnings season will bring an inevitable acknowledgement from companies that trade tensions increase the risk to forward earnings estimates, even if managements don’t formally lower the bar. Throw in the fact that these stocks have rarely, if ever, been so over-loved and over-owned, and the risk of a proper rain storm in this zip code increases significantly.
About three weeks later, a little rain did in fact come calling in the form a sudden lurch lower in FANG following Facebook’s Q2 fumble. After releasing a couple of additional notes reiterating the points made in the excerpted passage above, Wilson showed up on CNBC in what amounted to a last ditch effort to warn you that if you thought the late July showers were something, you were ill-prepared because the “proper storm” Mike predicted on July 8 was still coming.
So if your question is “who is Mike Wilson?”, the answer is: That’s Mike Wilson. And Mike Wilson has parlayed that bearish Tech thesis into innumerable TV cameos since the summer.
At this point, it’s pretty clear that Mike was correct in his July call and now, riding high, he’s back with a new piece called “Don’t Trade a Bear Like a Bull”. In it, Wilson kicks things off with a bang. The first line is: “We are in a Bear market.”
He probably could have just dropped the proverbial mic and ended it there (which would have been hilarious), but presumably basking in the glory of having called the worst correction for the Nasdaq 100 since 2015, Mike launches into a pretty extensive piece of analysis.
“Over the past several months, it’s become apparent even to the casual observer that the US equity market is acting differently”, he begins, citing a downturn in the 200-day moving average for the S&P and other major benchmarks, before delivering the real gut punch for the retail crowd as follows:
[This market] trades like a bear market [as] a buy-the-dip strategy has not worked this year, the first time since 2002. What’s notable about Exhibit 1 is the fact that the only years the Buy the Dip hasn’t worked was during bear markets, or the beginning of one (1982, 1990, 2000, 2002). In the cases of 1982, 1990, and 2002 it was also accompanied by a recession. In the case of 2000, it was the year preceding a bear market and recession and the topping of the TMT bubble. In other words, while 2018 is clearly not a year of recession, the market is speaking loudly that bad news is coming. Our view is that the market is sniffing out an earnings recession and a sharp deceleration in economic growth–something we have written about extensively.
And there it is. You’ve suffered through 1,268 words so far and now you can see the nexus. It’s Mike Wilson meets “BTD is dead” – a match previously observable only in the nightmares of retail Tech bulls.
What accounts for the demise of “BTD”? Well, if you read this far and/or if you frequent these pages, you already know one plausible answer.
“Quantitative easing has turned to quantitative tightening with the Fed now reducing its balance sheet and the ECB and BOJ tapering their QE programs”, Wilson goes on to write, confirming what most astute market observers have been warning about for at least a year.
Mike goes on to say that “while there may be other factors, we think [QT] is the primary one that has left investors wondering why even companies that report good news are seeing their stocks sell off.”
There you go. How many times have you been warned over the past two years that once the marginal, price-insensitive bid from the benefactors armed with the printing presses starts to fade, risk assets will lose their luster? And how many times did some newly-minted “asset manager” with a bunch of Twitter followers tell you that QE wasn’t behind ongoing risk asset inflation?
Now ask yourself if it’s a coincidence that, as BofAML’s Barnaby Martin wrote earlier this month, “just 23% of markets have managed to record positive total returns this year” – i.e., during the same year that QT got going in earnest.
As a brief aside, do note that you did not have to be a permabear, a doomsday blogger or some kind of conspiracy theorist to predict that the rolling back of the liquidity tsunami would cause problems. That’s what made it so absurd that so many glorified retail investors spent the past several years bending over backwards trying to equate everyone who warned about the rolling back of accommodation with the buy canned goods/gold crowd. And by the way, that’s what a lot of these popular Twitter accounts are – glorified retail investors. Just because you self-published a book one time does not make you a guru and just because you convinced a bunch of people to pay you to buy ETFs on their behalf does not make you “an asset manager” in any real sense.
Anyway, Morgan Stanley’s Wilson goes on to say that the de-rating damage (i.e., the multiple contraction) is probably done. Now, it’s just a matter of “waiting for the earnings cuts which will dictate how much more downside is to come.”
In that context, Mike cites Nvidia, which is now the poster child for what can go wrong. Mercifully, the stock found its footing a bit on Tuesday, but that’s small comfort. The shares have lost nearly half their value since the beginning of October thanks to a truly astonishing two-day rout.
So, we’ll see how things pan out when management teams start issuing full-year guidance.
In the meantime, we’ll leave you with one final, glorious quote from Mike:
Playing rallies from the low end of our trading range (2650-2825) is fine, but just understand that’s a bull market strategy. In a bear market, the winning strategy is to sell rallies. Old habits are hard to break but sometimes that’s what is necessary.