Why Buying Stocks “On Sale” Doesn’t Work Like You Think

Buy what’s “on sale.” That’s what they say…

Too bad it doesn’t work. Or at least, it doesn’t work like you think.

You don’t want to buy stocks like you buy clothes…

[ad#Google Adsense 336×280-IA]When clothes are marked down, they are usually a good deal. It’s probably a good time to buy them.

The same is not true for stocks… based on history.

When stocks are marked down, day after day, it turns out, they are not a good buy over the long run.

Let me show you an example of what I mean today… And then I’ll share with you when it actually IS a good time to buy stocks that are “marked down.”

What has happened in Canada this month gives us a perfect example…

Canada’s benchmark stock index (the S&P/TSX Composite Index) fell for eight straight days from November 4 to November 13. This is a rare extreme.

Canadian stocks were “marked down” for eight straight days. Should you buy Canada now based on this? No, actually…

Let me show you why…

Based on history, eight days of “markdowns” actually points to underperformance over the coming months…

Specifically, looking back over the past 25 years, the S&P/TSX Composite Index has only experienced eight or more consecutive down days on five other occasions. The last one was back in June 2002.

Whenever this has happened, Canadian stocks continued to drop in the near term, on average. Take a look at the table below. It highlights the forward returns after each of these five occurrences…

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Canadian stocks fell roughly 6% in the three months after these markdowns, on average. Six months later, the average loss was 2%.

The numbers get “less bad” further out, with an average 2% gain a year later… But that’s still a large underperformance compared with the typical 6% annualized gains Canadian stocks have produced over the past 25 years.

The point is, just because a market is “marked down” for eight consecutive days doesn’t mean it’s a good time to buy. History tells a different story.

So when do you want to buy “the losers”? How do you successfully pick winners out of historic losers?

The secret is your TIME FRAME.

In short, you need a loser to be a loser for a long time before it will become an outperformer.

Three years is about right…

If you’d simply bought Canada’s stock market after it fell for three straight years, you’d massively outperform over the next few years. Take a look…

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Canada’s stock market tends to SOAR after falling for three straight years. But the “markdown” needs to happen over a long period of time before it’s a buying opportunity.

The two basic lessons here are:

After short-run underperformance (one year or less), DON’T bet on a reversal.

After long-run underperformance of a group of stocks (like three years), it’s OK to bet on a long-term reversal of that group.

Picking market bottoms is all about your time frame… Remember this, and you won’t get caught trying to get cute calling the bottom when it’s not really there…

Good investing,

Steve

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Source: Daily Wealth