Guess you should’ve bought the dip. Who knew, right?

Even absent the myriad structural factors which tend to tamp down volatility (which is anyway mean reverting) and put a floor under stock prices, you should know that equity pullbacks are more likely to be buying opportunities than falling knives, and not just because stock prices “always” go up on a long enough investment horizon.

Central banks spent the better part of a dozen years post-Lehman optimizing the Pavlovian response function that says vol expansions should everywhere and always be sold and risk-asset dips bought. One of my favorite quotes on the subject comes from since-retired Deutsche Bank rates strategist Aleksandar Kocic who, just a month prior to 2018’s “Volmageddon” event, wrote the following of policymakers’ control over markets:

Through their communication with the markets, central banks, and the Fed in particular, have become “good listeners” with their decisions and actions made with markets’ consent. After years of this dialogue, the markets have gradually surrendered to the ever-shrinking menu of selections that converged to a binary option of either harvesting the carry or running a risk of gradually going out of business by resisting. Not much of a choice, really. In this process, central banks have reached a point of enormous power and control where market dissent is practically impossible. We believe that such levels of market control remain uncontested with anything we have seen in recent history and that the markets’ dynamics have never been further from that of the free-markets. Low volatility is a perfect testimony to that.

A few weeks later, the short-vol bubble blew up in spectacular fashion, but not before it minted money for everyone from the savviest of pros to homegamers shorting vol from their suburban living rooms via a suite of now-extinct inverse VIX products.

It all comes back to the notion that, as Nomura’s Charlie McElligott’s fond of putting it, “If you’re short vol, you make money but eventually die. If you’re long vol, you die before you make money.”

Some folks long vol probably made money earlier this month when the (untradeable, you’re reminded) VIX managed to one-up its “Volmageddon” performance with an absurd 42-vol intraday spike into a hopelessly illiquid pre-US-cash-equities-open void, but more money (a lot more) was made shorting vol over the past 18 or so months. The equities trade’s a mirror image: Sure, you could’ve made some money on bearish bets this month, but how many times did you go out of business since early 2023 burning up other people’s money on premium to protect against a crash that never materialized?

The point is: We live in a world where the psychological deck’s stacked against sustained equities drawdowns. Everyone involved suspects everybody else will buy the dip, which means the rational thing to do is front-run their buying to score easy gains, knowing the whole thing’s ultimately backstopped by monetary policy. It’s a combination of Pavlov’s dogs and the greater fool dynamic. It briefly went out of fashion in 2022, when a generational inflation surge struck the vaunted “Fed put” dramatically lower, but with price growth back near target and some labor market indicators evidencing softness, the policy put’s probably 15% below spot equities at most, which means your maximum loss buying the S&P down ~8% (as it was earlier this month) is just another 7% or so.

That in and of itself is reason to buy dips. But, as alluded to here at the outset, it goes well beyond that. Vol expansions aren’t sustainable. A lot of investors — maybe even most investors — don’t understand that. Sooner or later, equities will fail to “live up” to vol-implied daily swings, at which point vol will recede. Add in mechanical vol-selling from proliferating premium income ETFs with embedded options strategies, the constellation of other systematic vol-sellers and the impact on vol of downside hedge monetization following an equity selloff, and the bar to clear for a prolonged bout of turbulence is almost impossibly high. Pros know that, which means the first instinct in a vol shock is to exploit the situation by selling rich vol.

Of course, modern markets are populated by vol-sensitive investors, many of “whom” re-risk and re-allocate based on volatility levels. Once vol starts to recede, they’re buying. Mechanically. As spot moves back up through key levels used by trend-following strats, the managed futures crowd starts buying too. Again, mechanically. Meanwhile, corporates are executing into the drawdown. For example, Goldman’s buyback desk witnessed a huge increase in volume last week, suggesting the rebound in equities from the August 5 lows was at least partially attributable to opportunistic companies coming out of the earnings blackout guns blazin’ to reduce their float at “bargain” prices.

The point, in case it isn’t clear enough, is that in addition to the bid attributable to classical conditioning, there are structural factors which explain the fleeting nature of equity dips in modern markets.

The simplest of simple figures (above) gives you some context for just how pronounced the “reversion” has been over the last 10 days (eight trading sessions).

That’s not, of course, to suggest that selloffs are impossible to sustain, nor that crashes can’t happen. Indeed, some of the very same dynamics mentioned above can (and do) amplify selloffs depending on the circumstances. But it is to suggest that the odds don’t favor sustained equity drawdowns.

So, no, there was nothing at all surprising about the 875bps recovery in ES1 from the August 5 lows to the August 15 highs, nor the — and try not to laugh — 51-vol intraday peak-to-trough VIX deescalation over the same period.

You should’ve bought the dip.