Don't Buy The Dip...Yet

Summary

• The decline in the stock market this year was primarily caused by step 1, the deflation of a number of asset bubbles.
• Recently, investors and executives have rather suddenly become concerned about a recession.
• A recession would be step 2, I have listed 17 reasons why it's likely in the next year.
• Recessions almost always drive the stock market lower due to lower earnings expectations.
• This article covers why you shouldn’t buy this dip, and what to look for to get back in.

PictureSyndicate/iStock via Getty Images

Buying the dip has made a lot of people a lot of money. It works great for years, until one day it doesn't. That day is usually when a bubble bursts or a recession is apparent. This year we have both. Multiple bubbles have burst and are facing a recession. Those who have bought the dips this year have taken large losses. It will eventually work again, it always does. But now is not the time.

In a normal market, which is over 90% of the time, one of my 4-5 core strategies is similar to buy the dips. I call it capitulation. But I have all but stopped it this year.

Headwinds

A recession is highly likely within a year based on a huge amount of headwinds right now. Those headwinds were detailed at length in my two most recent articles "Get Ready A Recession Is Coming" published on May 25, and "2 Hedges And An Investment For An Increasingly Likely Recession" published on May 18.

In those two articles I listed 16 headwinds which are shown below. Please go to the articles for details on each. I have added a 17th also below.

1. Inflation

2. Interest rates

3. War in Ukraine

4. Demand pulled forward by massive stimulus (probably the biggest one)

5. Stimulus fading

6. Consumer sentiment is near historic lows by some measures

7. IPO and secondary filings have fallen off a cliff

8. Corporate warnings about growth

9. Housing starting to decline after massive growth

10. Strength of the dollar

11. Bubbles bursting (primary cause of the 2000 and 2007-2009 recessions)

12. Chinese declining housing prices and Covid lockdowns

13. Inventory overstocked

14. The un-wealth effect of declining stock, bond and probably housing prices

15. Refinance cash out spigot shut off

16. Consumer credit balances increasing again

17. Executives now overwhelmingly expect a recession

Regarding #6 and #17, it is often a self-fulfilling prophecy if the majority expect a recession. A survey by the Conference Board published on June 17, 2022, showed more than 76% of CEOs and other C-suite executives expect a recession in their geographic region in the next 12 to 18 months or believe it is already here. This may be as important as any of the other headwinds listed above. If CEOs expect a recession, they reduce Capex and other spending. They hunker down and protect their balance sheets. Less spending reverberates through the economy. The CEOs are the smart money. They are the ones best seeing firsthand what is going on in their markets.

Why You Should Wait

There will be a time to load back up. In fact, 95% of the time it is a good time to buy the dips. The market has dropped 18-32% this year depending on what index you look at. Most of that drop was the deflation of bubbles in high flying stocks, IPOs, SPACs, meme stocks and the like. Most of those bubbles are now deflated.

We are just starting to see a market drop that is associated with a possible recession. If we don't get a recession, then a good case can be made we are at or near bottom. But based on the headwinds I mentioned earlier, I believe a recession is highly likely. The stock market has dropped much more than the current 18-32% in the last 5 recessions.

If a recession is coming, that means there is a lot of bad news yet to come. The market is news-driven. As I noted above, most of the decline so far has been from bubbles in high flying stocks, SPACs, IPOs, meme stocks and most recently cryptos bursting. People only started talking about a possible recession about a month or two ago.

If a recession does come, there will be a lot of damage done. Recessions occur for a reason. Usually, to correct massive speculation or overcapacity. We need that right now as we have experienced unprecedented speculation in many areas of the stock market and elsewhere. A shakeout is likely. The chart below shows the massive amount of new stock listings the past two years. Many of these companies are large money losers and will disappear now that the market for secondary offerings is mostly closed. This usually happens when there is a wave of innovation and investment. It happened to railroads in the 1800s, and internet stocks in the early 2000s.

PGM Global (data via Bloomberg)

Let the shakeout happen and wait until we see where the damage is. As Warren Buffett said, only when the tide goes out do you discover who's been swimming naked.

The canaries are already dying. Residential real estate, one of the mainstays of our recent growth is just starting to decline, but the drop has been sudden and sharp. Lower end retailers, just in the past month significantly reduced guidance and admitted to excessive inventories. A big inventory adjustment is coming very quickly and that means less buying by retailers.

Citi Research

There is no market leadership remaining other than possibly energy and that could change quickly.

When To Buy This Dip

Consider the following 3 indicators for when it is time to buy this dip.

1. Watch the economic surprise index trend. It is an aggregation of economic statistics showing whether they beat or missed economists' expectations. Right now, it is trending rapidly downward. Once it is solidly back in positive territory is a buying signal.

Citi, Bloomberg

2. Don't fight the Fed. Wait until the Fed is done or is indicating it will soon be done.

3. Wait until the barrage of bad news slows. The market is news-driven and bad news drives it down. Why fight that? There is always a lot of bad news going into a recession. Most of that is ahead of us. Also, if the bad news stops driving the market down, that is also a buying signal.

Takeaway

The primary downward headwind in the stock market is shifting from bursting bubbles to recession fears. The bubbles we had are mostly deflated, though these often overshoot to the downside. That deflation has driven most of the market decline to this point. A recession is a different situation. It causes further market losses due to declining earnings estimates. The "E" in the PE ratio is earnings. That process hasn't really gotten started other than in certain industries such as lower income facing retailers and home builders. Once it does, look for another leg down.

This is not the time to be buying dips. But a great opportunity awaits for those nimble enough to take advantage. My best returns by far have been in the first full year immediately after a recession, each of the last four recessions.

Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such 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.