An Opportunity
Key Takeaways
The equity market rose this year on the back of low volatility- typically a feature of bull markets.
Investor positioning however, has many still very heavily over-allocated to bonds vs. equities given the expectation of rate cuts this year. At the moment there is a wide gap between equity and bond performance.
So the question for those feeling the burn of opportunity cost is: When is a good time to re-invest in a rallying market?
Nothing so undermines your financial judgement as the sight of your neighbour getting rich.
— J.P Morgan
Since Nov 2023, equity investors had gone through five months of a relatively smooth rally. (Unfortunately, the same cannot be said of bond investors currently). The rally was a continuation of the good equity market performance of 2023 — something that nearly nobody had expected, given the vast number of predictions of an oncoming recession last year. It is a good thing that we rarely base investment decisions on predictions and opinions, and instead defer to rely on evidence and data. When reviewing the numbers, the probabilities pointed to markets preforming decently last year, and that constituted the bulk of our advice to clients at the beginning of 2023:
So for the vast majority of investors who had been on the sidelines and out of the equity market for the past year or even longer, they face a difficult decision — when to re-invest in a market which had continued to go up and seemingly will not come back down anytime soon? Investor positioning at the start of 2024 showed that many were still very over-allocated to bonds and underweight to equities.
The Expected Pullback
It appears that the rally is finally taking a pause now and the pullback that we had always been expecting has finally come — likely triggered by an unforeseen or innocuous reason. After all, there’s good economic data, stronger-than-expected jobs, manufacturing, CPI, and retail sales data — all these suggest that inflation is likely to linger around for a little while longer and that economic growth is solid enough for the US Federal Reserve to wait for more evidence before beginning to cut rates. This blows out the predictions made at the beginning of 2024 of the possibility of up to seven rate cuts this year. At the moment, market pricing of interest rate futures indicate an expectation of only two cuts now.
Not All Setbacks are Equal
Good economic numbers, matched by a decent start to the first quarter of the corporate earnings season — these indications should form the case against a sell-off happening. However, a correction is always positive to reset the balance and allow some optimism (especially in some sectors) to blow off. Stocks that had gone extremely well this year have recently come off the boil.
For instance Nvidia, a recent investor darling is down around -16% from its recent market peak on 25 Mar (chart below). However, not all stocks have suffered this magnitude of correction. As such, this emphasises yet again why diversification helps an investor stay seated — case in point, a globally diversified basket of stocks is down less than -4% during this same period.
Silver Lining, or Storm Cloud?
As always, we turn to the data and evidence
So is this the opportunity that investors have been waiting for? It does seem to be. However, there is the worry that the sell-off could be the start of something much more nefarious. It appears that many investment strategists believe so, as the following reports suggest:
The recent stock market selloff was just the start of a deeper correction that’s on the way, JPMorgan’s top equity strategist warns.
The stock market is primed for a short-term bounce, but correction still not over.
'Overdue' pullback in US stocks to test dip-buyers' resolve.
When we view the evidence and data, it looks that this is just a breather with the expectation that the rally will continue till the end of the year.
For instance, this consolidation comes at a time of the year when pullbacks have been common. Reviewing a near 100-year history of the US stock market, which combines the one-, four-, and 10-year cycles, markets tend to take a break at the end of April to May. Perhaps this is where the old adage “Sell in May” comes from. However, do note that this does not happen all the time and we would warn anyone trying utilise this pattern to time this on a consistent basis.
The blue line in the chart below shows the aggregate of all years with the yellow dashed line representing what has happened so far in 2024. Looking out till the end of the year, it appears that we could be headed to more gains this year.
When there is a sell-off in stocks, measures of financial stress start to rise. In particular, VIX — a measure of the expectation of the volatility tied to the S&P 500 index — tends to rise during periods of uncertainty.
The following chart shows previous large volatility spikes (red ovals) which tended to coincide with previous market downtrends. However, volatility during the recent sell-off has not risen significantly, and should the stock market continue to recover from here, we should not see the VIX spike to previous high levels that are indicative of a further market correction.
In order not to belabour the point, another simple momentum indicator (50 day and 200 day moving average) is still positive. Whilst shorter term momentum shows that there is indeed a correction taking place, there had not been significant deterioration to longer term momentum which is an important indicator for long term trends of the stock market. Positive momentum coincides with positive stock market performance.
Hence, Therein Lies The Opportunity
As such, the present market situation presents an opportunity to add on more capital to investments to help boost the long-term returns and increase the probability of success for your investment plan. The base case is that the long-term uptrend of the global stock market still remains intact. Could the market continue to experience more sell-offs and volatility? Definitely, but as always, we lean towards the breadth and weight of the evidence approach and will shift according to how the data changes.
If you would like to find out more about the details of the investment consultation that we do for you, come and speak with us or raise this question during our regular progress meeting.
