This is one of those times to just buy the dip, one strategist says. There are always risks out there and -- sure horrible things could soon happen to the market -- but this is a sentiment echoed by many on Wall Street.
What Has Happened:
Since September 2, the S&P 500 is down almost 9% and was down more than 10% -- a technical correction -- earlier Thursday. The index has been dragged lower by tech stocks , which have a heavy market cap weighting in the S&P 500. The Nasdaq 100 is down more than 11% since September 2 and was once down as much as 13% from that date. Tech stocks had outperformed value stocks by a wider margin this year than they did before the dot com bubble burst at the start of the century. The customer acquisition by stay-at-home services like cloud, streaming and online retail has been off the charts. While some analysts note that the lockdown-driven awareness of these trends may drive a larger total available market for some tech sub-industries, the prevailing narrative has been that a substantial pull-forward of demand should reduce valuations for these stocks.
During the larger tech correction, there have been several head fakes in which investors seemed to buy-the-dip, followed by more weakness in the sector. Thursday, after tech started the day down, the Nasdaq 100 rose 1% by 2:20 PM EDT, a stronger up-move than most head fakes during the month. It’s possible the correction is easing and the fact that the Nasdaq 100 seems to find support this month near its Thursday level is an encouraging sign.
But value stocks have participated in the sell-off as well. Investors tend to move into growth tech, which is not entirely correlated to economic growth, when they are looking for alternatives to value stocks, which are more correlated to changes in the economy. Tech valuations soared in August and investors felt good enough about the continuation of the V-shaped economic recovery even though economic data were beginning to be mixed. But as Republicans and Democrats in Congress have failed to agree to terms on what would likely be a smaller fiscal stimulus bill than prior ones this year, confidence that the recovery can remain sharp has fallen. Monetary stimulus is the floor to the economy and market, with interest rates unable to fall more from here, the Fed exhausting all of its new tools in the bond markets, small businesses not fully reopened and unemployment still above 7%. Congress needs to get free money into the economy or else economic output in 2021 may not return to 2019 levels. And while a vaccine will be nice, liquidity in the economy matters too. The Vanguard S&P 500 Value ETF (VOOV) - Get Report is down 7% since September 7. That encapsulates less volatile defensive stocks, so some cyclical ones have dropped harder.
So stocks have dipped.
Strategists say to Buy:
But "Since we began looking for a period of correction driven by a pullback in the mega-cap “stay-at-home” areas, we suggested adding exposure as the pullback unfolded due to out positive fundamental core thesis,” wrote Tony Dwyer,” Chief Market Strategist at Canaccord Genuity in a note. "Summary – [the market is] passing over the first speed bump.” Dwyer also noted that only 25% of S&P 500 stocks are trading above their 50-day moving averages, which constitutes an oversold condition. Morgan Stanley’s Chief U.S. Equity Strategist Mike Wilson agrees with Dwyer’s general position and has been noting in his research investors should look for a pullback amidst what he sees as a brand new bull market that began March 23, the low of the bear market.
One reason it seems sensible to buy the dip -- whether that means long-term investors buying an index fund or short-term traders buying oversold stocks -- is because the risk with the highest likelihood of coming to fruition right now is more of a near-term risk. No fiscal stimulus likely means a slowing recovery, which means earnings per share on the S&P 500 probably cannot hit $165 for calendar year 2021, which is what the aggregate forecast calls for. At 21 times the next 12 month’s EPS ($155), the index is not priced expensively relative to unprecedentedly low interest rates. It hit 25 times earlier this year with the real 10-Year Treasury yield where it is now — 0.67%. That was an appropriate correlation, many strategists noted.
So if EPS estimates are forced to come down, the market would drop a little bit and it may have already reflected some portion of that drop in profits.
One factor to consider, though, is that the virus is experiencing an uptick again as the weather gets colder. More lockdowns will not be greeted nicely by markets and this would cause another leg downward in profit projections.
Another risk: valuation compression. The recent correction hasn’t been extremely deep, and it has shown signs of resilience. Plus, Dr. Fauci says a coronavirus vaccine could hit the market in a few months and 700 million doses could be distributed in the U.S. by April. That would certainly help. But if the economy suffers enough and the White House and Congress do not want to spend too much, the stimulus job could be left to the Federal Reserve, which seems almost out of new tools. Monetary stimulus is unlikely to be additive to economic output, but rather supportive at this point. Long-term yields are near the rate of inflation, not above, and the short-term lending rate is near 0%.
Even with a “Blue Wave,” the federal debt burden has jumped, and it may only take a few centrist Democrats to curb spending ambitions, as it currently seems unlikely the Democrats could take the Senate by a wide margin.
On valuation compression, the S&P 500’s aggregate multiple could come down if big tech multiples remain pressured. Earnings growth for the heavy tech hitters is still expected to remain strong for several years, but if the long-term picture has been pulled forward too much, the valuation pressure could meaningfully offset earnings momentum, a sentiment noted by many macro strategists.
The point: for those who believe we are in the middle of a new bull market -- and it would be hard to argue against that with the S&P 500 up 45% from its March 23 low -- this may indeed be at least a decent buy-the-dip opportunity.