‘Buy The Dip’ Declared Dead As Margin Accounts Turn Negative

For the first time in nearly two years, investors are deleveraging.

Despite a favorable seasonal and reasonably strong earnings, US equities suffered grievously over the past several weeks. That may be both a cause and a consequence of falling debit balances.

“Margin accounts turned negative in April,” Morgan Stanley’s Mike Wilson observed. “Rising rates are increasing the cost of margin while markets are 15-20% lower from 2021 highs, hurting the ‘buy the dip’ mentality,” he added.

The figures (below) illustrate the point. Unfortunately for anyone betting on a swift recovery for beleaguered equities, the relationship between changes in margin balances and stock performance is relatively tight.

“We think lower liquidity will continue to point to a broad de-rating and lower prices at the index level,” Wilson went on to say.

To be sure, investors’ deeply ingrained Pavlovian response function won’t be so easily unlearned. It’s not just about central bank liquidity and the vaunted “Fed put,” which is now struck much lower thanks to generationally high inflation. Data compiled by BMO’s Brian Belski shows that over the past 50 years, non-bear-market corrections have been followed by robust rebounds in US equities. Specifically, the S&P jumped 14% on average over the ensuing three months and 27% over the next year.

“While the slide has certainly been painful, it’s important to note that market retests of correction lows are quite common, and don’t necessarily indicate that US stocks are headed for a longer and more severe drawdown,” Belski said. “While only time will ultimately tell us when the correction bottom occurred, we do know that strong market gains have historically followed such bottoms.”

The problem with that kind of analysis is that it’s an exercise in question-begging. That is: If you don’t count corrections that turned into bear markets, stocks tend to do well following corrections. Although it’s handy when someone comes along and quantifies how well, as Belski did, there’s still something tautological about the analysis.

New research from Sundial Capital suggests 2022 is among the worst years ever for dip-buying. Through last month, the S&P actually fell slightly on average following down days. In Pavlovian terms, the bell is ringing, but no food is forthcoming.

It’ll take repeated disappointments for investors to disassociate declines with the kind of quick rebounds that characterized the long-running, buy-the-dip regime, but it’s worth noting that on a five-decade lookback, the only other year during which average returns following down days were worse than they’ve been in 2022 was 2018, the last time the Fed embarked on simultaneous rate hikes and balance sheet runoff.

Sundial’s conclusion was blunt: “Buy the dip is dead.”

I’d offer a word of caution. “Buy the dip” has been declared dead on too many occasions to count. In that regard, it’s a lot like the four-decade bond bull market. Reports of its demise are, almost as a rule, greatly exaggerated.

We write this obituary all the time. And whenever we do, it ends up being premature. It’s always the same story. Analysts read the last rites, the time of death is announced, then the financial media lowers the coffin and shovels in the dirt. Everyone says their polite goodbyes, and a few linger, graveside, to bid a personal farewell to a dear friend.

No sooner have the last tearful mourners left the scene than the dirt moves. A horn pokes out. Then a hoof. It’s never long before the bull, resurrected, is back above ground, alive to fight another day. Or another decade.