Buying The Dip Here May Be Reasonable, But It Is Far From A No-Brainer

by: The Balance of Trade

With momentum names crumbling, those looking to buy the dip might look at investing in value ETFs.

Short-term, realized volatility is in the upper percentiles of its past 12 years of observations.

Volatile periods can continue to escalate, and there is no sense in which the past decade's buy-the-dip pattern needs to continue.

Unless otherwise specified, data comes from FinanceYahoo! and was posted by the author using 'R'.

Chart AMZN data by YCharts

The momentum names (FB, AMZN, NFLX, GOOG) that led the markets higher are now rolling over in a big way. Because of the collective size of their market capitalization, the broader S&P 500 (SPY) could suffer the consequences far more dramatically than well-diversified segments that do not contain direct exposure to these companies.

I argue that the Vanguard Value ETF – the VTV – represents a safer way to gain equity exposure here.

Relative Performance

Between January 2017 and July 2018, large cap growth stocks (VUG) outperformed large cap value. Over this time frame, risk taking and momentum were by and large in vogue. Now that volatility has begun to flare up, growth names are enduring a large helping of the punishment. What goes up…

I argue that it will be difficult for growth to retake the helm at this time. If you are considering increasing your stake in equities, a shift toward value is advisable in my opinion.

If we head back to 2007, on a total return cumulative basis, value has trailed most of the sector SPDRs. There is nothing intrinsically flawed with the Vanguard Value strategy, apart from the fact that it is likely the index was heavy in financials at the inception of the crisis. This is really no different from the fate suffered by the tech-heavy growth index circa 1999.

For those who believe that many excesses have built up in the stock market, the cumulative wealth chart argues that these build-ups may be less pronounced in the value segment of the market. Of course, this visual does not display earnings or cashflow growth by sector.

Why Stepping In Here May Not Be Advisable

As of October 29 th, the 5-day volatility for VTV is in the 81 st percentile for the period between 2007 and the present. The ten-day and monthly are now near the top quartile. So you are well within your rights to be alarmed by the current behavior for this index (or stocks in general). Alarm that leads to rational questions followed by thoughtful responses is healthy, while alarm that leads to panic and knee-jerk reactions is counterproductive.

As we saw in the last piece, the drawdown (as of October 26 th) is well within the confines of our typical corrective experiences over the past 10 years. But I highlighted that there is absolutely no reason that this correction needs to resolve itself in the same direction or on the same tidy timeline as the others.


To get an appreciation for just how remarkable the last decade has been, look at the year-by-year performance for the Vanguard Value Fund. Even in light of the recent activity, VTV is up a little over 6.00% as of last weekend. In the entire decade, there has only been one year where the entire large cap value space closed down modestly lower (2015). This is not a “we’re due” argument as such; rather it is simply a statement that we do not want to put too much weight on the particular fashion in which recent bouts of volatility have resolved.

Analysis of Moments: Daily Returns

FinanceYahoo! – VTV, Total Return Basis

VTV’s standard deviation of daily returns over the past twelve months is very much in the middle of different samples depending on how far back one is interested in looking.

What really stands out over the last year relative to other trailing periods is the modest total return and the very high level of negative skew. This metric speaks to the incidence of large, negative returns that do not find offsetting positive events.

Even when one takes into account the period that includes the financial crisis, realized skew today is off the charts.


Oh for the days of 9.45% annualized standard deviation!! The Morningstar data above features five years of data (I presume monthly), so the month of October will only nudge these metrics higher.

The main idea that I want to strike at here is that, psychologically, the 1.23x Sharpe Ratio may well give investors some very unrealistic expectations as to what an equity environment looks like. The last five years have showcased an extremely high return-risk ratio by historical standards.

Risk-Return Comparison

Here we see non-overlapping ten-day returns and ten-day periodic volatilities for VTV, going back to 2007. As might be expected, most of the data centers around low-vol, low positive return data. The “origin” in the graph above marks the average 10-day realized periodic vol for the horizontal axis, and the average 10-day return on the vertical axis.

The period in 2008 and 2009 really was an era unto itself (observe the colored data to the far right). The regression line does indicate that there was a negative empirical relationship between realized vol and returns for the period under consideration (2007-present).

That said, the relationship is not as strong as some suppose. Volatility is an intrinsically symmetric concept. In and of itself, it does not take sides between large upswings vs. downswings. It is true that when markets drop, vol itself tends to rise, and this is why investors tend to conflate the nature of volatility with the kinds of environments where they tend to observe it.


Buying the dip here looks tempting:

A strong value tilt may reduce some of the rebound potential, but will also have the likely result of steering investors clear of any continued carnage in momentum names that make up such a large share of the growth index.

Still, there are reasons to believe that the worst is not behind us. Nobody can call the low, and that most certainly includes me. In my opinion, the nature of the multiple V-bottoms of the last decade may have deluded investors into a Pavlovian sense of false expectancy: the market does not have to rebound at all.

That goes for growth, and that goes for value.

If you are going to invest here, consider doing so in a diversified way, dollar-cost averaging, and utilizing similar risk management strategies.

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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.