Making Cents with Liam Croke: Buy the dip but watch out for the dead cat

Liam Croke


Liam Croke


Making Cents with Liam Croke: Buy the dip but watch out for the dead cat

I’m receiving a lot of questions from people asking is now a good time to invest, given how some markets and sectors have declined in value by over 20% in the past couple of weeks.

And when a market reduces in value by 20% or more, historically this has been a very productive time to invest, particularly if your timeline for not needing access to funds is greater than five years.

Obviously, if you were invested for a short period of time i.e. less than one month or year, the performance of markets has been terrible news, but if you’re investing for the next decade, it’s great news.

Josh Brown, CEO of investment advisory firm Ritholtz Wealth Management, said, “If you’re under 60, the universe just gave you a gift this week. Use it.”

The gift he’s referring to is buying into a market and individual equities at lower prices, because, as history suggests, share prices will recover over time, as they’ve always done in the past.

When it comes to investing in times like this, there is a term used called buying the dip. And it means you’re buying equities because you feel their loss in value is a temporary one, and they’re going to move higher, once markets return to normality.

And, if we look at what’s happened to it’s a really good example. They are an Israeli software company, providing cloud-based web development services.

On March, they were trading at $110.88 per share. And on March 18, their share price had fallen to $77.18, even though their business model hadn’t changed and was unlikely to change post-Covid-19.

But they got caught up in the contagion that spread throughout markets and their share price fell in value by 30%.

If you thought this drop was only going to be temporary, and you didn’t think their share price would drop any further, you could have purchased stock at $77.18, which you thought was their dip price, believing it had dropped as low as it would and that it would only increase in value.

If you did this, it looks like you made the right decision because their share price, closed on March 19 at $102.14, an increase of 32% in just one day.

When you hear about buying low and selling high, that’s really what buying the dip means, and you can see this in action with Wix.

You’ve got to be careful though, because the rebound could also be temporary, and the share price might go into freefall again.

When this happens, it’s known as the dead cat bounce, because even if a dead cat falls fast and far enough, it will still bounce.

At first the increase in share price might be seen as a reversal of the downward trend, but it’s quickly followed by a continuation of the downward share price. And it becomes a dead cat bounce when the share price drops below its previous low.

So, buying the dip doesn’t necessarily mean or guarantee you’ll make a profit.

It doesn’t mean that just because you’re buying at a cheaper price than what it once was, that it’s still good value.

The equities you’re buying could decrease further. If you remember back to the days when the share price of Irish Banks were falling. Some people thought they were buying the dip, because they didn’t believe the share price could drop any further, and it did, so you’ve got to be wary and be selective in the shares you buy.

There is an index you may or may not have heard about and it’s called the VIX index, and it’s often referred to as the fear index.

When it’s believed that markets will correct or crash the fear index goes up, and when markets are performing well, the index goes down.

The reason why I want you to know about it, is because a high VIX number is a leading indicator of when the market is hitting the bottom.

It’s a signal when you should start buying equities. There’s a saying that when the VIX is high, it’s time to buy, because when you examine the VIX number in detail, it can give you an excellent idea of what’s to come next, and that’s typically high future returns.

When the VIX number is greater than 40, that’s when markets begin to panic and start a sell off. And given the VIX at the time of writing this article is at 74.25, it would further validate the notion that now seems like a great time to invest.

It reached a similar number back in 08/09 and we saw how the market bounced back following that particular crisis.

The likes of Warren Buffett believe that stocks are on sale right now thanks to the coronavirus, and his mantra is: be fearful when others are greedy and greedy only when others are fearful.

From a financial perspective, now might be that time to be greedy. If someone offered you a discount for clothes or for a car at 25%, it would get your attention, the same applies to the stock market right now.

Entry prices are much lower, and new investors in particular have the benefit of starting without any losses. But the market may fall further in the short term before you begin to see any up-side and you’ve got to reconcile yourself with this happening, and that’s fine by the way if you’re happy with taking risk and you’re in this for the long term.

And no matter what I or others say, you have to be careful, nonetheless. There is another expression when it comes to investing during, and in the aftermath of, market crashes: is it ever wise to catch a falling knife?

So, be cautious, but my gut is telling me now is a good time to invest, and the best way to do this is buying a basket of funds that are invested in different sectors with companies located all over the world.

Investing in individual stocks requires an understanding of industry trends that most people don’t have. A fund that invests in different sectors and companies allows you to lower your risk by buying into an investment that’s already diversified.

I would recommend you reach out and speak with your financial adviser or find one who can tell you about these types of funds.

And let me tell you, there are plenty of them out there, you just need someone to guide you and tell you about them.

No one really knows how long the market turbulence will last for, and whether the worst is over or not. So, trying to buy at the lowest point, even if knowing what that is is just guesswork.

And if someone happens to buy at the very bottom, they’re just lucky. If you can buy near the bottom then great, but I would start investing as soon as you can. This crisis will pass, it’s difficult to know exactly when, but it will.

Maybe a good strategy for a lump sum investment is staggering how much you commit to, by investing 33% now, a further 33% in April and the remaining third in May or June when hopefully the virus is under control and we have a clearer picture about how markets will react to that good news.

Finally, experienced investors will tell you that, if you’re investing for the long term, anytime is a good time to invest, so now is probably as good a time as any to invest cash you’re not using and don’t expect you’ll need for a period of time (at least five years).

But don’t think this is an opportunity for quick wins either, because you may be disappointed. Unless you’re investing money, you can afford to lose, I would caution you against this course of action. Finally, stay indoors and practice investment distancing from yourself.