‘Buy the Dip’ Has Never Been More Popular in U.S. StocksBy
“Buy the dip” has never been so popular.
The practice of treating any and all pullbacks in risk assets as opportunities to accumulate more has become entrenched in global equity markets, especially in the U.S., according to analysts at Bank of America Merrill Lynch.
“Investors no longer fear shocks but love them,” a team led by global equity derivatives researcher Nitin Saksena wrote in a note Tuesday. “Since 2013, central banks have stepped in (or communicated that they may step in) to protect markets, leaving investors confident enough to ‘buy-the-dip.’”
Intraday realized volatility for the S&P 500 Index relative to the realized volatility in the open-close ratio for the benchmark gauge has soared to record highs this year, emblematic of an environment in which buying the dip has become gospel for traders, according to the bank’s analysis of price action going back to 2003. This ratio is also above the 90th percentile for the Euro Stoxx 50 Index and Nikkei 225.
In practice, this suggests any early weakness in stocks is being met with an onslaught of buying that propels the index back to where it opened by the time the closing bell sounds.
BofA equity derivatives strategist Clovis Couasnon puts it this way:
Imagine the S&P 500 Index is down 1 percent at midday, only to rebound and finish broadly unchanged. The open-to-close return would be close to zero, but under the surface there were two moves of about 1 percent.
“So if the buy-the-dip behavior is strong enough to cause mean reversion, this will cause intraday vol to be more supported than open-to-close vol,” he explained.
That mentality has been rewarded in 2017 as the market has climbed, with bounce-backs from some of the biggest retreats happening in record time. It took just three sessions for the S&P 500 Index to fully repair the damage caused by May 17’s 1.8 percent decline -- the quickest recovery from a five-sigma selloff since 1962, according to BofA.