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

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.