Ask the Rational Investor: Should you buy the dip?
At the market correction’s low point, the S&P 500 and Nasdaq were down around 20 and 30% for the year. Most major indices have now recovered several percentage points from those lows begging the question should investors buy the dip?
For over a decade since the financial crisis of 2009, investing has been easy due to cheap money from very low, and in some cases, negative, interest rates. Inexpensive money gradually trickled throughout every asset class, causing prices to rise.
Now, we find ourselves living in a different world, and the tailwind of easy money is shifting toward a more restrictive monetary policy. This transition should not be confused with moving completely to a restrictive monetary policy, as interest rates adjusted for inflation are still negative. A restrictive monetary policy would be interest rates above the average inflation rate.
As global monetary agencies initiate this transition there will be bumps along the way. Already Europe looks like it is falling into a recession and the US economy seems to be headed there, too.
Most economists anticipate inflation being around 3-3.5% toward the end of 2023, about 50% higher than it has been for over a decade before the pandemic. Deglobalization trends combined with supply chain vulnerabilities will likely result in additional inflationary pressures, as will further regulation of carbon-based energy.
With this economic perspective, investors need to consider what will cause stocks to rise over the next several years. After the pandemic, very easy money policies raised the valuations of stocks from approximately 15x earnings to 20x earnings. During this time period earnings grew and were rewarded with increasingly higher valuations. A great situation for stock investors!
Going forward rising interest rates are likely to counteract price-to-earnings multiple expansion and could even cause them to decline in some cases. As a result stock appreciation will be a result of earnings growth and dividends.
A good investment for the intermediate term is likely one that won’t experience further valuation compression as interest rates rise with growing earnings and a healthy dividend.
Beese Fulmer Private Wealth Management was founded in 1980 and is one of Stark County’s oldest and largest investment management firms. The company serves high-net-worth individuals, families, and non-profits, and has been ranked as one of the largest money managers in Northeast Ohio.