VIEW ONLINE The market's 'Red October' nailed the coffin on one of the most trusted trading strategies of the bull market — and Morgan Stanley warns it could send stocks tumbling
- A trading strategy that has rescued stocks and generated big profits for investors throughout this bull market is no longer working.
- Strategists at Morgan Stanley outline why we're witnessing the end of "buy the dip" and the urgent implications this development has for stock market investors.
The longest bull run in the stock market's history is showing more signs of its age.
The market action around last month's sell-off — dubbed "Red October," as it was the worst drawdown in seven years — demonstrated that stocks were not recovering from such downfalls as briskly as they used to.
Months before the market registered its historic bull streak earlier in 2018, Bank of America Merrill Lynch strategists flagged that the strategy known as buying the dip was not working the way it used to.
The October sell-off corroborated this assertion, according to strategists at Morgan Stanley.
"October was not just a technical sell-off like the one in February," Michael Wilson, the firm's chief US equity strategist, said in a client note.
"We now have fundamental drivers: higher interest rates, slowing economic growth next year, margin risk, and tighter financial conditions," he said. "They all add up to investors holding less risk and, without incremental money flows, this new primary downtrend will likely take time to reverse."
In other words, there are now serious downside catalysts that make it harder for investors to pour their cash back into stocks after downturns, leaving the market more vulnerable in such moments. Chief among these stimuli in October was the persistent rise in interest rates, which, according to Wilson, put stocks in overvalued territory for the first time since January.
Read more: BlackRock's $1.9 trillion bond chief explains how everyone is misunderstanding the cause of market turmoil
To prove the demise of dip buying, Morgan Stanley ran the numbers on the S&P 500's average daily performance if the prior week's return had been negative. The ideal scenario for a trader who buys at the low of a weekly decline is a subsequent rally.
But this outcome has not been the case in 2018. As this chart shows, based on these parameters, buying the dip has experienced its worst track record since the early 2000s.
Wilson is not forecasting that investors will no longer buy dips, nor is he recommending that they stop the practice. After all, buying stocks consistently without regard for their price is a smart way for long-term investors to lower their cost of trading over time — a practice referred to as dollar-cost averaging.
He is saying, however, that investors should henceforth brace for more volatility as stocks attempt to recover from their losses.
Wilson saw the October slump as a manifestation of the rolling-bear-market thesis he had espoused for more than a year prior. The rolling bear market is now morphing into a "chopping" bear market, he said, characterized by wilder swings and smaller rallies. Besides higher interest rates, investors are worrying about rising labor costs and how this might eat into corporate profits next year, and the shrinking balance sheets of the world's biggest central banks.
"For the rest of the year, we think US equity markets are likely to remain very choppy but in a narrower range," Wilson said.
"In terms of the S&P 500, we think the wider range of 2400-3000 we posited at the beginning of the year has likely narrowed to something like 2650-2800 — but with bigger intraday swings and hard-to-anticipate price action." Read » | | | | | Advertisement | |  | |  | | | | | We have updated our Privacy Policy to reflect global privacy standards. We encourage you to read the updated policy in full. By continuing to use our sites, services and apps, you agree to these updated terms. If you would like to opt-out from receiving emails, please click Unsubscribe here . 
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