Six reasons why buying in 2022's global shares' dip may make sense
Buying the dips has usually made sense. In the 14 years since the financial crisis, it has generally paid to assume that central banks or the government would ride to the rescue at the first sign of trouble in the markets. Don’t fight the Fed has been a profitable mantra.
It’s not just the desire of the authorities to keep the show on the road that has encouraged the view that a correction is always an investment opportunity. The arithmetic may say so too. To illustrate this, imagine a hypothetical market that rises by 10% a year, with biggish annual swings between a 20% gain and a 10% decline. Now imagine two investors, one of whom only invests at the top of those cycles and one at the bottom.
Self-evidently, the one who buys the dips does better. But the scale of the outperformance may surprise you. If each investor puts $100 a year into the market on this basis, one will end up after five years with $560 and the other with $745, a third more.
Obviously, this is an unrealistic scenario, but you get the picture. Buying the dips makes sense in a rising but volatile market. And, given enough time, rising but volatile is what markets tend to be.
Buying the dips is less obvious today than it has been because investors are worried that there might be something fundamentally wrong with the global economy right now. Two years ago, the arrival of the pandemic was an unexpected and unpleasant shock to an otherwise healthy market. Today, the ground beneath our feet feels shakier. But is it really?
Six reasons to believe in global stocks
Here are six reasons to believe that buying global shares’ 13% dip since the start of the year may make sense - if not in the short run, then in due course.
1. Sentiment. Risk aversion is one of the best indicators that the time has arrived to get back into the market and sentiment has not been this weak since the low point of the financial crisis. The percentage of investors describing themselves as bearish was last this high in 2009. Even in 2003 after the unwinding of the dot.com bubble, people weren’t this pessimistic. That’s a good thing because there is usually an inverse correlation between the mood of investors and the future returns from stock market investments. Not always, because investors can get gloomy well before the market hits bottom, but often enough for sentiment to be a useful signal
2. Pricing in trouble. The extent to which investors have already priced in trouble ahead. The bond market tends to be a better place to find these signals than the stock market because fixed-income investors are natural pessimists and, as a result, better canaries in the coalmine than perennially optimistic equity investors. The measure I’m looking at today is the yield on safe government bonds. At 3%, the income from a super-secure 10-year US Treasury bond looks to have priced in pretty much all the interest rate rises that are currently spooking investors. Again, that’s a good sign. I’d be surprised if bond yields go much higher than this for the foreseeable future.
3. The equivalent measure of sentiment in the stock market is the multiple of earnings that investors are prepared to pay for a share of a company’s profits. This so-called price-earnings multiple has been falling for more than a year now. Last spring, investors were ready to pay maybe 24 times the earnings of America’s biggest companies. Today, it’s just 18 times. I don’t have the greatest conviction that this measure won’t fall a bit further yet, but it feels closer to the bottom than the top of its likely range.
4. The price-earnings multiple is determined in part by price and in part by earnings. It is a ratio. So, what happens to company profits is clearly important. The good news on this front is that roughly halfway through the UK earnings reporting season (covering the three months from January to March) about 80% of companies are beating expectations. It’s forecast that earnings will have risen by nearly 9% on average during that period, up from an expected 5% at the start of this reporting round.
5. Buying this dip is Mr Market’s tendency to overshoot. Here, it doesn’t make sense to look just at the averages but to seek out potentially more extreme examples of over-pessimism. Like the 47% fall in Cathie Wood’s Ark Innovation ETF or, closer to home, the 32% slide in the Scottish Mortgage investment trust share price so far in 2022. Or Amazon’s 25% drop year to date.
Things are rarely as good as we hope or as bad as we fear, and I wonder whether, when the war is over, inflation has fallen back and Covid has finally been eliminated, we will look back on some of these price movements and wonder why we didn’t act on them.
6. Investing is long-term. In the long run, the dips simply disappear from the charts or at least start to resemble harmless pauses for breath. The biggest mistake we can make as investors is to be shaken out of the market by these temporary setbacks. The second error is not to take advantage of them by topping up along the way. We can’t hope to emulate the investor who only ever buys at the bottom of the dips. We don’t need to. Investing steadily through the ups and downs is a good second best.
Never miss an insight
Stay up to date with all my latest Livewire content by clicking 'follow' below.
MORE ON Equities
Tom joined Fidelity in March 2008. He acts as a spokesman and commentator on investments and is responsible for defining and articulating the Personal Investing business’s investment view. Tom is an expert on markets, investment trends and themes.