Stock market rebound: Why it may be ‘too early to go all-in’ by buying the dip

A big rebound in the stock market after a lousy January could reflect misplaced confidence in an already proven trading strategy, a Wall Street analyst warned Monday.

“After a sharp decline in stocks in January, some investors expressed interest in ‘buying the dip,'” Lisa Shalett, chief investment officer at Morgan Stanley Wealth Management, wrote in a note. for most of this economic cycle, we think it’s too early to go all out.”

The start of 2022 has been volatile. As of the January 27 close, the S&P 500 SPX Index,
was down 9.7% from its record high in early January, leaving it just below correction territory – defined as a pullback of 10% from a recent high. The Nasdaq Composite COMP,
was down 15.7%, Shalett noted. The selloff came as investors began to price in a series of much more aggressive rate hikes and other tightening measures from the Federal Reserve in an effort to tame inflation.

The Fed, following its January 25-26 policy meeting, signaled that rate hikes, likely starting in March, were indeed underway. Soon came the rebound, with the S&P 500 falling 4% from its January 27 low through Friday’s close, while the Nasdaq rebounded 5.6%.

Shalett said bulls were quick to latch onto technicals indicating an “oversold bottom” and took comfort in historical data showing that the Federal Reserve’s tightening announcements over the past 60 years were precedents for stock market rebounds.

Shalett acknowledged that history can be a useful guide and that most market cycles and regime shifts show patterns “rhyming” with the past, but cautioned that each cycle is unique – and that the current, as policymakers grapple with the effects of the COVID -19 pandemic, could be especially so.

The picture is complicated, in part, by the market’s historically abundant liquidity (see chart below), she said, warning that markets have yet to adjust to its possible withdrawal.

Morgan Stanley Wealth Management

Although interest rates have started to reflect the Fed’s expectation of rate hikes this year, that’s not all. The chart above shows the Goldman Sachs Financial Conditions Index – higher readings mean tighter conditions. The gauge indicates that market liquidity remains near its best level in three decades, about three standard deviations below the average of previous business cycles.

“Critically, although some argue that the Fed’s policy pivot to higher interest rates is embedded in the bond market, we disagree,” she wrote. “Current rates may reflect Fed guidance as it stands, but the cut is not yet complete and financial conditions remain near the most accommodative level in history. growing risks, as multiple interrelated factors, including the actions of other central banks, could affect Fed policy.

It won’t be until rates start to rise and the Fed offers more detailed guidance on its balance sheet reduction plans that stocks will “better reflect the new reality,” Shalett wrote, arguing that, in the meantime, investors should be prepared for an environment that favors stock picking with an emphasis on “defensive, cyclical stocks with quality, undervalued cash flows.”

Stocks struggled for direction in Monday’s session after the S&P 500 and Nasdaq posted their best weekly performance since late December on Friday. Major benchmarks swung between modest gains and losses, with the Dow Jones Industrial Average DJIA,
up 102 points, or 0.3%, in afternoon trading, while the S&P 500 and Nasdaq each rose 0.1%.

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