A sideways look at economics
There is an outbreak of war (trade or real): buy the dip. Financial scandal uncovered at a health insurance company: buy the dip. An expensively valued meme stock misses earnings: buy the dip. No matter the catalyst, I have a friend who will always justify his plans to buy the dip (BTD), while encouraging me to do the same. I’ve been receiving similar advice for many years. During 2009, my Money & Banking professor told us that it was a generational opportunity to buy equities. His view, which turned out to be correct, was that most blue chip companies wouldn’t go bust, and that it was a good time to be greedy. It’s been a good time to be greedy ever since. Throughout my adult life, economic shocks have been met with forceful policy responses. No wonder that a generation of retail traders, who frequent the likes of r/wallstreetbets, lean into volatility rather than away from it.
In April 2025, at the peak of trade tensions, when some institutional investors were selling risk, retail buyers were bargain-hunting, adding a net $40 billion into US equity markets. Since then, a BTD strategy has outperformed some of Wall Street’s cautious elite. On 9 April, the S&P 500 was down 15% from its end-2024 level. It has increased more than 20% since then, with retail staples up by even more: Bitcoin (+30%), Palantir (+57%) and Robinhood (+100%).
What happens after the first 15% drop? The table below looks at episodes where that has happened with the S&P 500 since 1927. From the -15% trigger date, the median drawdown continues to a -24% trough, and the mean trough is deeper at -32%. The round trip back to the previous peak takes 17 months (median) or 46 (mean). Long-term investors often have to wait a long time just to get back to square one. Those who enter on the trigger date (dip-buyers) do better: a 15% BTD rule looks attractive. On average, the S&P 500 is in the black one, three, six and twelve months after a 15% fall, and the gains compound further over five- and twenty-year horizons.
Gains are positive on average but there is a large degree of variation at play, most notably during the Great Depression. Gung-ho investors, who bought the S&P 500 in October 1929, would have had to wait until June 1932 for the index to even trough. Things didn’t get much better from there: after ten years, the index was still down 47%. Even after twenty years, $100 put into the S&P 500 in 1929 would have been worth just $66 (excluding dividends), with those nominal losses even worse due to inflation of around 40% over that same period.
Some retail traders may be students, but they don’t seem to be swayed by ancient history. Instead, today’s crop seem to focus on recent drawdowns. A BTD strategy following drawdowns in 2020 and 2022 would have, respectfully, returned 54% and 18% after twelve months. After five years, the 2020 investment is up 117%, with the 2022 one up 61% after just three years. You would have to go back to 1973 for a BTD strategy to be underwater after five years. Even then, it was down just 1%. Meanwhile, a BTD strategy hasn’t been negative after ten years since the Great Depression, although admittedly the gain for dot com drawdown investors (+7%) was nothing to post on Reddit about.
Some, including us, have questioned whether US exceptionalism will persist moving forward. But there is no doubt about it looking back. A BTD strategy is biased by a long record of strong US equity performances that many countries cannot match. Moreover, there has been large sectoral dispersion hidden by a strong overall index. Ahead of the GFC, one error that investors made was to look at the history of national US house prices to conclude that they only go up. An international assessment would have shown that other countries often had house price crashes.
The most aggressive retail traders would be well served by looking to Japan. Buying the dip worked exceptionally well throughout the post-War period. Until it didn’t. As the following table shows, a BTD strategy for the Nikkei 225 would have been triggered twice in 1990, with the index at 28,759 the second time. It would not trough until 2009 almost twenty years later. And it would have been down by 64% after twenty years. Once again, these returns are nominal and so don’t factor additional losses via inflation.
So, a BTD strategy leaves you vulnerable to large but rare shocks. And US exceptionalism may not last. But perhaps its most fatal flaw is the opportunity cost of money sitting on the sideline, waiting for a drawdown. Using monthly S&P 500 data, I compared the ‘entry point’ for a -15% BTD strategy and compared the index on that trigger date with the level the last time the market had set a new all-time high. The average was 25%: the typical dip-hunter had already surrendered more than a bull-market’s worth of gains before getting the opportunity to put cash to work. Dollar cost averaging is the best method to accumulate returns over the long term.
It’s easy to make fun of trigger-happy retail traders. And it’s hard not to see signs of froth in certain parts of the investment landscape. But to be fair to amateur investors, they have cottoned on to a truism that others may sometimes forget: although dips may coincide with bad news, they can still be great times to buy. Whether by luck or not, many individual investors seem to have cottoned on to the fact that April’s sell-off was overdone. Perhaps they realised that it was being driven by discrete policy choices and was therefore ripe for a U-turn. Perhaps they simply got lucky. A word of warning: buying the dip works. Until it doesn’t. The next 15% drawdown could be a buying opportunity, or the beginning of a Japanese-style lost decade. Position yourself accordingly.
A special thank you to Jessie Lamping who, during her work placement, helped with this week’s blog.
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