The right time to buy stocks: when they’re expensive

“Buy the dips” is a hoary old investment cliché. I think buy the dips is shabby advice. There’s a better way to do it…

Of all the hoary old investment clichés, “buy the dips” must be the hoariest.

The idea is straightforward: buy stocks when they’re cheap, sell ‘em when they’re expensive. Seems logical right?

I remember when I first got into the world of economics and investing back in the mid 2000s, I used to read Greg Mankiw’s blog. Mankiw was one of the first economics bloggers. He used to head George W. Bush’s Council of Economic Advisors – a sober, conservative sort.

Mankiw’s one and only investment strategy was to sell stocks when they’re trading above historical averages and buy when they’re trading below average. He was the first of many people to advise me to buy the dips.

I’ve been thinking about all buy the dips stuff stuff lately though, having read Steve Sjuggerud in the Daily Wealth.

I think buy the dips is shabby advice. There’s a better way to do it…

A forward looking strategy

Look, we can all agree that if you look backwards at the stock market, the best time to buy is when stocks are low. That’s not in dispute.

The problem is that in real time it’s not possible to tell whether you’re in a trough, or if stocks have further to fall. And it’s not possible to tell in real time whether stocks are peaking, or have further to climb.

Lots of investors make this mistake. They buy when stocks are low relative to their recent performance, at 12-month lows. And they sell when stocks are doing well, at their 12-month highs.

Sjuggerud has crunched the numbers: that’s a losing strategy. Buying the dips is one of the worst possible times to buy. And buying at the “tops” is one of the best times.

How could this be?

Highs all the way up

The basic intuition behind it is that stock markets tend to go up much more than they go down. They make new all-time highs about 10% of the time.

And if you think about it, all time highs don’t just come out of the blue. They happen in long streaks. When conditions are right, the market makes chains of all-time highs. The highs follow on from another.

Here’s a chart of the first seven years of the FTSE 100 index. From 1992 to late 1997 it went on a long run of all-time highs. If you sold out of the market because you were worried it was hitting 12-month highs, you would have missed out on four and a half years of amazing returns.

rr-23-09-16
Source: Capital IQ

I could show you similar charts for the S&P 500 in the US, or any stock. The point it that stocks, and stock markets, don’t suddenly jump in value. They gradually climb in value over the course of months and years.

Just like growth stock investing

Sjuggerud shows that, at least in the US, buying at 12-month highs has been a better strategy than simply buying and holding. Over 80-odd years, the one-year returns on the strategy beats buy and hold 6.9% to 5.6%.

Sjuggerud’s insight reminds me of the best Penny Share Letter stock picks. When you pick a winning company, it doesn’t just shoot up overnight. Its share price builds steadily, hitting new highs all the way up. I stick with those companies until they’ve shown their full potential.

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