There’s still a significant amount of fear among investors. But the best thing to do is ignore it, except when it creates buying opportunities by pushing stocks down. Then you should thank the bears for creating better entry prices. Here are six reasons why you should buy that weakness, when it happens.
1) The economy is not likely to go into recession
A lot of analysts fear a recession again, because of a false signal from the labor market. We are not going to see a recession any time soon for the reasons I cite below.
* First, that false signal in the rising unemployment rate. The unemployment rate is the number of people working, as a percentage of the labor force. By definition, it goes up when more unemployed people (defined as anyone actively looking for work) join the labor force even as the job market remains healthy. That’s what’s happening now. Companies continue to add to payrolls. But unemployment has been going up because the labor force is growing faster than that job creation, notes Jim Paulsen, who publishes strategy commentary at Paulsen Perspective on Substack.
* Real wages (accounting for inflation) continue to rise, points out Ed Yardeni of Yardeni Research. “Wage increases are not indicative of a weak labor market,” he says.
* Managers at consumer-facing companies say the consumer is strong. Goldman Sachs economist Jan Hatzius tracks executive sentiment towards the consumer in earnings calls. In the second quarter his system found their sentiment on the consumer reached its highest level since 2022. He expects a “robust” 2.4% consumer spending growth in the second half.
* As I predicted in July 2023 MarketWatch column, there’s a productivity boom in the U.S. Productivity grew 2.7% in the second quarter year over year, well above average. Strong productivity is good for the economy because it boosts earnings. It also limits inflation because it eases pressure on companies to pass along cost increases.
2) Stocks hold up better when conditions are right
While stocks can be weak this time of year, stocks do much better when interest rates are falling and the monetary supply is growing, says Paulsen.
3) The Fed put is back
The Fed is on a rate cutting campaign. This will support economic growth, investor sentiment, and stocks. Bank of America global economist Antonio Gabriel thinks the Fed will cut rates by 25 basis point at each meeting until March 2025.
Some analysts point out that historically stocks do poorly when the Fed is cutting rates. But that’s just because the preceding rate hiking campaign typically caused a credit crunch that broke something (the housing market in 2007-08, Long Term Capital Management, etc.). That’s not the case this time around. Yes, there was a mini banking crisis. But despite dire predictions of a widespread bank sector demise by Elon Musk and Tucker Carlson, the bank issues did not spread.
4) The “carry trade” is unlikely to unwind a third time
In the carry trade, investors borrow money at low rates in countries like Japan and invest it in markets with higher yields and economic growth that supports stocks — like the U.S. When the Yen rose this summer, it started to eat into profits from this trade. It meant carry traders had to pay more to buy Yen to pay back the debt. They scurried to sell U.S. stocks close the trade. This carry trade cover has hit U.S. stocks twice in the past several weeks.
But the risk of a third hit is fading, says Eric Wallerstein, chief market strategist at Yardeni Research. “Macroeconomic conditions in Japan and the U.S. led us to believe that a third episode of the carry trade unwind is unlikely or won’t be extreme,” he says. “We expect tamer inflation pressures in Japan and stronger growth data in the US to prevent the yen from strengthening dramatically from here.”
5) Sentiment is not nearly high enough to make the market vulnerable
Since the stock market fools most of the people most of the time, we’d need to see excessive investor bullishness to set the market up for a sharp pullback. But that is not the case.
I follow about a dozen sentiment indicators to make market calls in my stock letter, Brush Up on Stocks. But if you track just one, make it the Investors Intelligence Bull/Bear ratio. This one runs on a scale of 0.5 to five. Anything above four is a warning sign of excessive bullishness for me. The most recent reading on September 11 came in at 1.92. For me, any measure below two tells me the market is buyable since sentiment is so weak (in the contrarian sense).
A Bank of America Sell Side Indicator, which tracks the suggested stock allocation among sell side strategists, is neutral. It is at 56.2% which suggests a return of 11.5% for the S&P 500 over the next 12 months, says B of A strategist Savita Subramanian. Meanwhile, she says fund managers are cautious. They have been selling cyclicals like energy, materials and consumer discretionary which do well when the economy is strong.
6) Stocks hold up better during election years
In election years, the U.S. stock market performs no worse than average, MarketWatch columnist Mark Hulbert points out here.
A few favored stocks: NVDA, GOOGL and RH
Two stocks that look attractive in part because fears about September-October weakness have pushed them well below August highs are: Nvidia (NVDA) and Alphabet (GOOGL). Nvidia and Alphabet now look cheap, according to Peter Lynch’s price earnings to growth (PEG) ratio. It weighs forward pe’s against long term earnings growth estimate. Lynch said for growth stocks, a PEG ratio below 1.5 signifies cheapness. Nvidia has a PEG ratio of .66. Alphabet trades at a PEG ratio of .92.
It’s harder to make a valuation case for RH (RH), which I suggested in a July 23rd MarketWatch column, because it is up over 20% since then.
But RH will benefit from the pickup in homes sales as mortgage rates continue decline. Since I predicted that trend in late July, the 30-year fixed mortgage rate has fallen to 6.2% from 6.78%, and this trend will continue.
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