Is it time to buy the dip?
Buying the dips in 2021 was probably the best strategy to approach US equity markets. Whenever the S&P 500 dropped 4% to 6%, it was followed by a sharp rally, with the index ending 26.9% higher for the year. Many investors now believe we're so close to the end of the pandemic, which could be true given the low mortality rates driven by the latest Omicron wave. However, does it mean 2021's strategy will work this time?
Three weeks into 2022, the reopening trade in which investors bet on economically sensitive stocks had been in play. The value factor outperformed the growth factor significantly, suggesting that investors are dumping Tech and stay-at-home stocks and looking for safety in banks, energy, and other value sectors. However, the weight of value is way smaller than growth, so it's not surprising that the Nasdaq Composite declined 11% from its peak, while the Dow Jones Industrial Average fell by 5% only.
Market participants are now pricing four 25 basis points rate hikes in 2022 compared to zero in early 2021. That's a significant shift in sentiment and justifies the selloff in interest-rate sensitive stocks like Tech. The good news is that the shift in sentiment didn't lead to a market crash. On the contrary, I would call it a healthy correction so far, but nervousness remains there.
The S&P 500 has fallen by 5.9% from its January Peak, which would have been considered a strong buying signal in 2021. Interestingly, the index fell below its 100 days moving average in yesterday's trading session. If it remains below the 100 days moving average for another one or two days, it may encourage further bears to join the selloff. Traders will need to closely monitor the 4,495 level (Dec 3 low), which should play significant support here.
Higher interest rates on their own don't necessarily lead to steep selloffs. When central banks tighten monetary policy, it's because the economy is doing good. What investors need to worry about is inflation. If inflation remains stubbornly high despite interest rates hikes, that would be problematic to stocks. Central banks would then force the global economy into a recession, and we all know how stocks perform when a recession hits. However, looking at bond markets, traders still believe inflation will be below 3% on average over the next five years. It may be considered a good time to start looking for bargains if bond traders are right and earnings remain supportive.