The 'buy the dip' stock market strategy is about to make a comeback as long as the Fed doesn't move goal posts, Fundstrat says

  • The “buy the dip” investment strategy is poised for a comeback in 2023, according to Fundstrat.
  • That’s as long as the Fed doesn’t move its own goal posts on inflation and interest rates.
  • “We think the conditions are warranting a return of ‘buy the dip’ even with a Fed which is increasingly looking behind the curve.”

The “buy the dip” investment strategy that was shellacked in 2022 is poised for a big comeback this year, according to a Wednesday note from Fundstrat’s Tom Lee.

That’s as long as the Federal Reserve doesn’t move its own goal posts on inflation and interest rates. The Fed is expected to hike interest rates by 25 basis points at its FOMC meeting Wednesday. 

Lee based his assessment of a potential return of the popular buy the dip strategy on the recent easing of financial conditions.

“Equity markets starting to play a different game, focused on easing financial conditions,” Lee said. As long as financial conditions ease to a level the Fed can tolerate, buying the ongoing declines in stocks should prove fruitful this year, according to the note.

That’s because inflation has seen a marked step-down from its elevated levels over the past few months, with the most recent data on the employment cost index being below economist expectations.

“Wage pressures also tanking evidenced by the 4Q22 employment cost index coming in at 1%, down from 1.4% [in] 2Q22 and within ‘spitting distance’ of 0.9% needed to achieve 2% overall inflation,” Lee said.

The Fed has telegraphed that it is targeting a long-term inflation rate of about 2%, and it seems progress towards that goal is being made.

“Bond markets are now sensing [the] Fed has to ‘course correct’ by either pausing sooner (Feb last hike) or by cutting rates later in 2023,” Lee said.

If the bond market is right, then that should be a great setup for the stock market according to Lee, who expects gains of more than 20% this year. Lee is also encouraged by the bullish trifecta that was confirmed for stocks last month, which has historically led to very strong gains for stocks.

But the big risk to Lee’s bullish view is, as it was last year, what the Fed ultimately does.

“Fed could move the goal post and either try to hammer/threaten ‘higher for longer’ [interest rates] if financial conditions ease beyond what Fed would tolerate. Second, Fed simply makes a policy error and keeps tightening beyond what is necessary,” Lee explained. 

No matter what the Fed does, Lee is confident that the October 12 low in the stock market was indeed the bottom of this cycle. And if that’s the case, Lee’s expectation for a revival of the “buy the dip” strategy should benefit investors this year.