Many have been looking for a big market drop as an opportunity to get on board. But, as we know, markets rarely accommodate -- and the market's current refusal to correct has added to the frustration of those who continue to miss out. Of course, the longer-term market trend -- we're talking the history of the market -- has always been upward. The tricky part is knowing when to get in. Market timers claim they have the advantage of jumping in and out at exactly the right time, but it rarely works quite in this fashion. These folks will occasionally be right, but remember: A broken clock is right twice a day.
So, if you're waiting on the sidelines, is there a particular number that should get you back into the game? Well, in the past, drops of 10% to 20% did not represent immediate buying opportunities. In fact, the bigger numbers tend to designate the start of a bear market. If you'll remember, the market's slide from the 2008 peak was far deeper than 10%, ultimately leading to the March 6, 2009 low of 666 on the S&P 500 -- five years ago last week.
During the period leading up to that low, volatility rose and the fall was precipitous. Stocks would fall 10%, then extend the drop another 20% and then decline another 30%. It would have been deadly to try an entry. Still, I know many strategists, analysts, experts and pundits advocated getting in at every drop between October 2008 and March 2009. During any tumble like this, at some point these folks will be right. But how far behind will you be before that miracle hits?
Today, markets are at or near all-time highs, and no big correction has taken place for many months. In fact, since 2011 the best pullbacks have brought stocks down some 6% to 7%, and that hasn't happened often. So, from that standpoint, the market certainly seems to be set up for some significant move in the other direction.
Even so, dip-buying on 3%-to-5% pullbacks has worked out nicely, and often, during this period. But you may have rejected these opportunities, each time thinking: "This is the big one -- I'll buy down 10% or so." On the flip side, if you went short after a 3%-to-5% drop, expecting more downside, you got burned -- fast -- as we saw most recently between late-January fall into those new mid-February highs.
So I certainly suspect the next 3%-to-5% drop may be bought up again. Yet, at some point, that pattern will eventually fail as well.
A 10% market drop can happen quickly, and it would do more psychological damage than anything else, triggering an erosion of confidence and a surfacing of doubt. That confidence is the very thing that has been shored up by an aggressive Federal Reserve's bond-buying program (and fortunately the Fed hasn't sacrificed the dollar or buying power to achieve it). On a 10% drop, we would see a rise in fear via the CBOE Volatility Index (VIX) as selling pressure increased and put-buying ratcheted up.
Beyond sentiment-related shifts, though, a substantial drop would pile on selling from institutional investors as well as retail traders. We would see a significant shift in the market's character and structure -- and, of course, in the charts.
Of course, you may believe there's no harm in a 10% drop for the S&P 500. After all, that would merely get the index back to 1690, where it was a month ago.
But it wouldn't be as simple as that. We're talking confidence, behavior and commitment here. As many dip-buyers are accustomed to smaller drops, I can see many "waiting" to jump back in until they see a big drop settle out. Buying, in other words, would be bound to take a pause. Amid all this, if volume starts to rise sharply and consistently, we'll know distribution is of the institutional variety. The market's trend would likely turn downward, creating the ideal environment for finding some shorts or put plays as market players look for that momentum to persist.
So be careful what you wish for.
As for myself, in the event of a 10% drop I would mostly stand back until the smoke clears -- which would likely be after another 10% tumble! Either that, or I'd play it short for continuation of the pullback. I rarely look for tops and bottoms. That is a loser's game.