Michael Batnick, director of research at New York-based Ritholtz Wealth Management, presented the disquieting possibility this week that the “buy the dip” strategy in equity markets is dead. If he’s right, the necessary behavioural change for investors is likely to be a painful process.
In “This is Where Dragons Lurk,” Mr. Batnick began by suggesting that “investors’ mentality over the past decade can be summed up in three words: Buy the dip.” The popularity of the practice – which involves buying equities every time they sell off in any significant way – is easily explained by the fact that it’s been extremely lucrative since the financial crisis.
Mr. Batnick then described the importance of a widely used technical indicator, the 200-day moving average, in signalling a major change in market trends. The “200-day,” as it’s usually called, is just the average price of an asset over the previous 200 trading sessions. It forms a trend line over time.
More aggressive traders use the 50-day and 100-day moving averages for buy and sell signals, and some even use shorter term 15- and 30-day moving averages. The 200-day, on the other hand, is viewed as a measure of the longer term trend. A stock trading above its 200-day moving average is considered in an uptrend; below the 200-day implies a downtrend.
The S&P 500 is now trading well below its 200-day and for Mr. Batnick, “this is where dragons lurk.” He studied the 25 best and the 25 worst days for the SPDR S&P 500 ETF Trust, a proxy for the index, since its inception in 1993. Remarkably, 47 of those 50 trading days, or 94 per cent, occurred when the S&P 500 was trading below the 200-day.
It’s not a huge surprise that the majority of the biggest sell-offs happened when the market was in a downtrend. The fact that almost all of the biggest daily rallies also occurred during downtrends is a far bigger revelation.
This week’s volatile markets fit perfectly into this framework. The S&P 500 is below the 200-day, and we saw both a huge rally Wednesday and a nasty downdraft Thursday.
Downtrends are no time to be buying dips – the volatility can crush portfolio values. So-called bear market rallies are almost always intense, but when they occur, rising stock values must still be seen in the context of a bear market.
Mr. Batnick believes that unlearning the dip-buying habit will take time. “Investors lose confidence in the market slowly, then very quickly,” he wrote. “Each successive bounce gets weaker and weaker until the dip buyer’s confidence is exhausted.”
Mr. Batnick’s column provides a number of important lessons for investors. For one, strong single-day rallies aren’t to be trusted until the benchmark pops above the 200-day moving average (which, as of midday Friday, stood at 4,490.) Investors also need to exercise patience and risk management when making any investment decisions during downturns – avoiding speculative stocks is a good start.
This isn’t the most exciting advice, but doing nothing is probably the best course for investors for the near future. The risk of dramatic volatility levels causing losses is too elevated for all but the bravest investors.
-- Scott Barlow, Globe and Mail market strategist
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Stocks to ponder
Superior Plus Corp. (SPB-T) This dividend stock has been a laggard on the TSX and has been the worst performing company in the utilities sector. But analysts expect shares will rebound, and the stock is trading at a reasonable valuation. Next week, Superior will be reporting its financial results from its seasonally strong first-quarter. It was a cold winter, which may bode well for the company’s first-quarter earnings given a likely boost in propane demand. Jennifer Dowty looks at the investment case.
Boralex Inc. (BLX-T) Green energy stocks have been struggling through a topsy-turvy year of rising interest rates, supply chain challenges and the renewed allure of traditional energy marked by soaring fossil fuel prices. But David Berman says Boralex stands out with impressive gains that make it worth a closer look.
The Rundown
Is it time to snap up stocks with pessimism running so high? Not so fast
Contrarian investors like to say the best time to buy stocks is when nobody else wants them. If so, the pervasive gloom that hangs over global stock markets could be signalling a rare buying opportunity. But Ian McGugan did a reality check on this strategy and the results suggest investors better use caution.
Also see:
Market pain isn’t over, but you will get through this
Buckle up, say traders as Wall Street’s wild ride shows no sign of end
Fed fingers crossed for 1994 re-run as hiking path shortens
How to use short sellers to dodge torpedo stocks and hedge portfolios
The prolonged bull market that followed the stock market crash of 2008 was brutal for short sellers. But the tide appears to be turning for them now that runaway inflation is pushing central banks to hike interest rates and cool off the economy. Investors who simply go long stocks thus may want to avoid companies in short-sellers’ sights even more so at this point. Larry MacDonald looks at six of them.
Today’s preferred shares were built for a rising rate world - so why are they falling in price right now?
More than a dozen years ago, some clever investing people thought of a way to build preferred shares so they could thrive amid rising interest rates. So, how are preferred shares holding up so far? Not great. Rob Carrick explains what happened.
Why Elon Musk’s Twitter bid has shaken Tesla investors
Elon Musk’s deal for Twitter has features that make it risky, including billions of dollars of personal debt. If it goes wrong, it could burn Tesla shareholders and strain Twitter’s financial health. There are already signs of investor concern. Tesla stock has fallen 24 per cent since the disclosure early last month that Musk had taken a sizable stake in Twitter, a period in which the S&P 500 has declined 9.5 per cent. Peter Eavis and Jack Ewing of The New York Times report.
Crypto warnings invoke U.S. subprime bust and 2008 financial crisis
Regulators comparing the crypto craze to the U.S. subprime mortgage bust of the 2000s may seem like scaremongering, but the more crypto integrates with traditional investing and markets, the more prescient these warnings may become. Jamie McGeever of Reuters reports.
Others (for subscribers)
The highest-yielding stocks on the TSX, plus risk data
Number Cruncher: Fifteen U.S. tech stocks showing positive price momentum in a beaten-down sector
Number Cruncher: Ten quietly profitable TSX stocks that steer clear of controversy
Friday’s analyst upgrades and downgrades
Thursday’s analyst upgrades and downgrades
Lack of alternatives set to drive U.S. dollar dominance
Globe Advisor
Women invest for the long-term in top companies they know and understand
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Ask Globe Investor
Question: I have held Capital Power Corp. (CPX-T) for several years. With a current dividend yield of more than 5 per cent and steady capital growth, it has so far been a good choice for my dividend portfolio. But it has an extraordinarily high payout ratio of 543 per cent. Does it make sense to hold it expecting the dividend to be sustainable?
Answer: If you’re trying to determine the sustainability of a company’s dividend, don’t rely on the payout ratios published on financial websites. These are typically computer-generated numbers that provide no context or information as to how they were calculated. As a result, they often paint a misleading picture of a company’s ability to maintain its dividend.
Capital Power is a case in point. I’ve seen the same bloated payout ratio figure on several different websites; it appears to have been calculated by dividing the company’s total dividends of $2.12 over the past 12 months by its 2021 earnings per share of 39 cents.
There are a couple of problems with calculating Capital Power’s payout ratio this way. First, because of one-time factors, earnings often vary a great deal from one year to the next. Adjusted for such unusual items as impairment charges, foreign exchange gains or losses and changes in the fair value of assets, Capital Power’s “normalized earnings per share” were $1.97 in 2021. Using this higher earnings figure, the payout ratio was a less egregious 108 per cent.
That’s still uncomfortably high, which leads to the second problem with the way some websites calculate payout ratios: They often use inappropriate measures. With independent power producers such as Capital Power, earnings are often depressed by accounting charges such as depreciation that don’t affect the company’s cash flow or its ability to pay dividends. For that reason, analysts sometimes base the payout ratio on a company’s available cash flow instead of its accounting earnings.
In 2021, Capital Power’s adjusted funds from operations or AFFO – a cash flow measure included on its earnings statements – came to $5.40 a share. Dividing the company’s annual dividend per share by its AFFO per share produces a payout ratio of just under 40 per cent. That’s a heck of lot better than 543 per cent. It’s also comfortably below Capital Power’s own target payout ratio of between 45 per cent and 55 per cent.
So, the company’s dividend appears to be very sustainable indeed. What’s more, Capital Power has been raising its dividend for many years and is projecting annual increases of about 5 per cent through 2025. The company discussed this at its investor day in December; you can find a copy of the presentation in the investor relations section of its website.
Bottom line: With payout ratios, the numbers published on financial websites can sometimes lead you astray. In many cases, you need to go to the company’s financial statements and earnings presentations – and consult analysts’ reports if you have access to them – to determine if a company’s dividend is secure.
--John Heinzl (E-mail your questions to jheinzl@globeandmail.com)
What’s up in the days ahead
John Heinzl explains why TC Energy Corp. may be just the antidote investors need to cope with the current global turmoil. Plus, Rob Carrick will have more on the sudden attractiveness of GICs and Tim Shufelt examines the wreckage in the TSX tech sector.
The tightrope trick: World market themes for the week ahead
Click here to see the Globe Investor earnings and economic news calendar.
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Compiled by Globe Investor Staff