Buy the Dip on the S&P 500?

Should investors “buy the dip” when the S&P 500 declines? In this article, we have calculated the historical median forward total returns of the S&P 500 based on the severity of market drawdowns (also known as “dips”).

Interpretation:

The first row in the table above shows that the S&P 500 experienced drawdowns between -5% and >-10% for a total of 1,282 days. Investors who bought during these dips saw a 50% probability of achieving a 3-month return of 4.13% or higher and nearly 60% total returns over a 5-year period.

Conclusion:

There appears to be a negative correlation between the severity of drawdowns and forward returns across all time frames, particularly for periods of 3 years or longer. However, this relationship is non-linear. As the table shows, buying during a drawdown of -10% to >-20% is more profitable over 3-month and 1-year timeframes compared to buying during a -20% to >-30% drawdown. 

This phenomenon can be attributed to the trend-following nature of asset prices, which often extend declines past certain thresholds before mean-reverting higher. This effect is most evident in the case of severe drawdowns, where investors who bought at -50% or worse achieved the highest returns over any time period, as prices rebounded sharply after periods of extreme pessimism.