It has now been 47 months since the last ten percent correction occurred in the S&P 500.  This now stands as the third longest streak on record.  Since 1927 an adjustment of that magnitude has occurred on average once every eight months.  So conventional wisdom would say; “the next time the market dips, it’s finally going to drop 10%”.

No one would blame an investor that decides to sit on the sidelines with an ample amount of cash waiting for the opportunity to buy quality issues at a discounted price.  Economic, geopolitical and interest rate risk may make them more cautious than they would be if corrections occurred on a more frequent basis similar to past history.

Yet despite their patience, investors has not been rewarded with regards to investing in an index.  Since the end of November of last year, there has been nine “downturns” averaging just 3.86%.  The largest “correction” was 4.91% from November 28th through the 17th of December.  The shallowest resulted in a 2.92% decline and lasted nearly a month (May 20th through June 15th).

Based on the information provided an investor might assume that, since the market hasn’t really moved that much from the beginning of the year through July 31st (2058.90 to 2103.84), the individual stocks within the S&P 500 would also be relatively unchanged.  In the aggregate that type of assessment would be correct as 236 stocks have declined, 260 stocks have increased and the remainder began trading after January 1, 2015 and therefore the results are incomplete.

Human nature would lead you to conclude that there must be bargains within the 236 declining stocks.  A view of “Buying the dip” on one or more of these issues seems logical and might be a great way of “buying low and eventually selling high”.   Right now an example of this paradigm is no bigger than in raw materials and energy stocks.  The destruction that has occurred in those two sectors is staggering considering the performance of the overall indexes. 

Over the previous 12 months, raw material industry heavyweight Freeport Mc Moran is down approximately 68%.  Long time oil exploration and drilling stand out Apache has declined by more than 55%.  Aluminum producer Alcoa has dropped 40+%. Even the major oil integrated bellwethers Conoco, Chevron and Exxon have depreciated by approximately 39%, 32% and 20%, respectively.   

Of course, stocks that have declined this much must be a bargain, right? Since no one knows the future they could be the steal of a lifetime or might not have come close to reaching their lowest price during this move. 

Before purchasing any of these issues an investor must determine if they would fit into their portfolio.  They might be worth considering if your portfolio is light on energy or raw materials.  You would then need to spend a great deal of time understanding the fundamental trends of the companies and the industries they are part of.  Otherwise, just trying to catch “a falling knife” might not be a great idea because cheap stocks can always become cheaper.  

Think of the investor that bought Freeport when it was down 40% believing it was cheap.  Now looking at a price that is nearly 30% lower, they have to ask themselves was it really that cheap.   Maybe they truly believe in the long-term fundamental story or that the stock will rebound in the next twelve months and add to their position.  Maybe they want to take the loss and redeploy the capital elsewhere.

Prior to purchasing a “cheap stock”, an investor should know their risk tolerance. If you are a buy-and-hold investor you might want to determine if there is an event which will influence your decision to consider adding, maintaining or even liquidating the issue.  The last choice is usually the hardest, but it needs to be part of the equation.

If you are a believer in managing risk, what’s your game plan?  Are you willing to sell an issue if it declines 10%?  How about if it falls 20%?  What if you were correct by “buying low” and the issue does increase in value?  Will you follow the risk management principles and liquidate the issue if it violates such? 

Many investors will buy a stock, establish an exit plan, subsequently watch it have a significant rebound and end up abandoning their plan.  Then the stock will fall sharply to either provide little gain, a breakeven or maybe a loss. They will vouch on their life that the next time they get back to where it was trading, they will liquidate the issue.   Over the years I have witnessed this unfortunate event countless times when talking to prospects about their portfolios.

So remember; “buying the dip” is much more difficult than an investor believes.  If you are considering such, you might want to consult with a professional advisor who can play the “devil’s advocate” before you make that final decision.

If you have any questions or comments regarding this blog or any other thought, please contact me at trgblog@trgcap.com. Thanks for reading!!!

Sources:

http://www.bloomberg.com/news/articles/2015-07-27/s-p-500-propped-up-by-just-two-sectors-shows-bull-market-aging

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Tom is the Founder of TRG and has been the President and Chief Investment Officer since 2008.