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Robeco Outlook: Buy the dip, watch out you don’t trip

  • Cheaper stocks following January’s market plunge look tempting
  • Four factors from inflation to Ukraine means caution is advised
  • Markets should take it in their stride if growth remains above trend

Investors should be cautious about re-entering the stock market after the correction in January, says strategist Peter van der Welle.

US equities plunged by almost double digits on fears that persistently high inflation will force the US Federal Reserve to more aggressively hike interest rates. Five rate hikes together adding 1.25% to borrowing costs are now expected after US inflation hit a record 7%.

Normally a significant market wobble would tempt investors back into the market while stocks are cheaper. They should however watch their step, as four headwinds stand in the way of the bull market resuming, says Van der Welle, strategist with the Robeco multi-asset team.

Overarching question

“The overarching question bothering investors now is when is it time to buy the dip?” he says. “That’s a valid question, because when you look at the sell-off in developed market equities in the year to date, it roughly matches the historical average sell-off around the time of a first Fed rate hike, which we envisage will come in March.”

“The historical drawdown averages at 11%, and the S&P 500 Index lost 9.8% in January, so that’s close to bottoming out. Nonetheless, there are four main risks that markets need to navigate now, which keeps us a bit cautious about buying this dip in the multi-asset fund. Basically, this dip is not as easy to read as previous corrections.”

Inflation is the big problem

He says the main problem remains inflation, which has spiked following supply shortages as the Covid-19 lockdowns ended and energy prices soared, leaving companies and consumers with much less purchasing power.

“The first risk is that we think inflation risks are still skewed to the upside over the next few months, although we expect them to drop steeply after that,” says Van der Welle. “Financial markets are recognizing that the Fed is now in inflation-fighting mode and have priced in five rate hikes for 2022 to address this inflation risk.”

“This could create some further turbulence, but afterwards we think the markets will recognize that inflation is decelerating, at least in the cyclical parts of the economy. When you look at the base rate effects of oil prices dropping out, then overall CPI inflation should still drop to about 3.5%. This means it will have halved compared to current year-on-year levels.”

“The inflation risk premium – the compensation investors are demanding to shield them against unexpected inflation – has been declining lately. The inflation story has been top of mind over the past year, but this signal from the bond markets tells us that the market can navigate this.”

Consumers are key

The second risk is decelerating demand for durable consumer goods such as household appliances and cars as the pandemic ends and the service sector reopens.

“Durable goods consumption has skyrocketed on the back of all the elevated lockdown intensity over the last 18 months, when people could not go out to fancy restaurants, so they ramped up spending on durable goods instead,” says Van der Welle.

‘People could not go out to fancy restaurants, so they ramped up spending on durable goods instead’

“That will likely come down as economies further reopen once the Omicron wave has fizzled out. Declining goods consumption could result in declining manufacturing indicators such as the ISM. That could raise the risk of a growth scare, especially if the ISM were to drop below the 55 level (a reading above 50 signals growth).”

“The consensus real GDP growth forecast this year of 3.8% is consistent with an ISM of around 56. If we were to see a drop below that level, then the markets could be negatively surprised by it. Any growth scare could be short lived because a rebound in services activity should keep growth above trend, so it’s a risk that could be overcome by markets.”

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