Morgan Stanley
  • Wealth Management
  • Oct 22, 2018

Don’t Rush to Buy the Market Dip

Even though many stocks seem to be recovering from the recent sell-off, investors should resist the temptation to buy leaders that fell in price

Lisa Shalett Wealth Management Head of Investment & Portfolio Strategies

Purchasing stocks after a sharp decline is a strategy that has worked well for the past 10 years. After each correction, the market recovered and went on to trade higher. Dips have proven good opportunities to pick up market leaders in sectors like technology and consumer discretionary at cheaper prices. Investors have benefitted as many of those names recovered and eventually traded to new highs.

As effective as that strategy has been, I don’t recommend it now. That’s because interest rates have risen and I expect they may rise more in the coming year. Higher rates typically result in lower stock valuations (the forward price-earnings ratio is the measure of valuation most frequently cited), since many investors discount the value of future earnings when the yield of a low-risk investment (like a Treasury note) is rising. This phenomenon hits the highest priced stocks—including many tech and consumer discretionary names—the hardest.

Strong third-quarter earnings reports and positive economic news may lead to a near-term resurgence in equities, but I’m not convinced it will continue into next year if rates rise as I expect. My forecast is for stocks to trade in a wide, downwardly biased and volatile range for the next year. Below are a few additional reasons why:

  • Economic growth may slow as the stimulus provided by tax cuts starts to wane and pressure from trade tariffs increases.
  • The Federal Reserve is likely to keep raising rates, which taps the brakes on economic growth.
  • Larger fiscal deficits, a weakening U.S. dollar and more Treasury issuance could also lead to rising rates.
  • Many companies are facing higher costs, which puts pressure on profit margins.

Bottom Line: While it may seem tempting to buy long-term market leaders that have dipped in price, I recommend investors consider value-priced stocks in more defensive sectors instead. Watch corporate earnings reports for downward earnings revisions which could foreshadow a turn in market momentum. And keep an eye on interest rates, which could hold the key to the market valuations of the bull market’s highest fliers.

Risk Considerations

Yields are subject to change with economic conditions. Yield is only one factor that should be considered when making an investment decision.

Equity securities may fluctuate in response to news on companies, industries, market conditions and general economic environment.

Asset allocation and diversification do not assure a profit or protect against loss in declining financial markets.

Rebalancing does not protect against a loss in declining financial markets.  There may be a potential tax implication with a rebalancing strategy.  Investors should consult with their tax advisor before implementing such a strategy.

Because of their narrow focus, sector investments tend to be more volatile than investments that diversify across many sectors and companies.  Technology stocks may be especially volatile.

Investing in foreign emerging markets entails greater risks than those normally associated with domestic markets, such as political, currency, economic and market risks.

Certain securities referred to in this material may not have been registered under the U.S. Securities Act of 1933, as amended, and, if not, may not be offered or sold absent an exemption therefrom.  Recipients are required to comply with any legal or contractual restrictions on their purchase, holding, and sale, exercise of rights or performance of obligations under any securities/instruments transaction.

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