S&P 500 Has Fallen Into Bear-Market Territory. To Buy The Dip Or Wait? This Is What I’m Doing. 

IMPORTANT: Please read the disclaimer before continuing.

In my previous article (“Why Do Stock Prices Go Up Or Down After Earnings?”), I talked about how markets are always forward-looking. Subsequently, I wrote that companies with growing profits could potentially be good investments despite a tough macroeconomic environment. 

Today, I want to provide an update on what I’m seeing and further explain why I am not fully in cash. 

Everyone’s attention is on the Federal Reserve right now. It is raising interest rates to combat inflation and causing the stock prices of many companies to fall drastically.

Some argue that we should wait till the Federal Reserve stops talking about raising interest rates before putting money into the stock market again. But we know the stock market is forward-looking. 

In 2008/2009, we experienced the global financial crisis. The S&P 500 index bottomed in March 2009 before recovering. As for the economy, the crisis raged on for a few more months before the situation improved by June 2009. 

This proves that the markets move ahead of the economy.

To decide when we should put more money into the stock market, we cannot follow the Federal Reserve. It is using lagging economic indicators such as the Consumer Price Index (CPI). Released on a monthly basis, this index measures the costs of living. 

Instead, we should look at current indicators such as daily or weekly prices of oil and commodity prices. 

The good news is that the situation is improving. For example, prices of lumber, cargo transport, and copper are down. 

This means the cost of housing and transportation is likely to drop, bringing down inflation. Semiconductors giants such as Foxconn and Samsung are seeing better supplies in the months ahead too. 

(Source: CNBC)

The bad news is the oil prices right now. It will be the main determinant for inflation because higher oil prices will flow through the economic system, leading to higher inflation readings. Since the Federal Reserve is using dated data, it will continue to raise interest rates. Without any decline in oil price, I don’t see how the general stock market will recover any time soon.

If oil prices subside, it’s entirely possible for the market to rally before any word from the Federal Reserve. Remember, the markets are forward-looking.

That being said, there is still a lot of noise in the stock market. Increasingly, investors are consumed by the macroeconomic news. This may cause us to be more focused on the short term instead of broadening our time horizon. 

This is not the end of the world because what we are facing right now, like all past historical events, is temporary. 

The indices such as S&P 500 and Dow are often largely influenced by institutions moving their money in and out of the stock market. Institutions often rely on macroeconomic factors to make their decisions. Smaller companies are less affected because they are more nimble. The movement of their share prices are more dependent on growth of their earnings.

Unless you are buying the index, the idea of getting out of the market and staying on cash right now does not make sense. 

Take Note: The Content Below Is Applicable To Individual Stocks Only

The share price of any company is primarily driven by two factors: the price multiples and the earnings growth of a company.

In short, Predicted Return = Earnings Growth + Change in Price Multiples

Yes, higher interest rates are surpassing the price multiples/valuations of many companies now. Some companies, however, might not be badly affected if they have strong earnings growth.

What happens if price multiples come down and earnings continue to grow robustly? You’re buying a coiled spring ready to bounce off any time. What if these companies are already trading at attractive valuations? Is waiting further going to guarantee you lower prices given that the company’s intrinsic value is growing?

Opportunities exist when there is fear and uncertainty. 

Opportunities disappear when certainty is being restored. 

Looking Into the Past for Clues

During the global financial crisis, were there companies that made investors money?

I will use the great financial crisis as an example with two fictitious characters.

Scenario 1:

Henry picked out good companies with robust earnings growth and attractive valuations. He entered the market on 15 August 2008 and held until 4 February 2011. He was unlucky. He entered before the crash occurred. 

Scenario 2:

Cindy waited for a 30% increase from the bottom because she wanted confirmation of a stock market recovery. She entered the market on 7 August 2009.

(Typically during a crisis, when an index recovers 10% to 20% from the bottom, it does not signify a full recovery. It could be a bear rally. This is why I used 30%.)

From these two different scenarios, I am going to measure their returns until 4 February 2011. That’s when the stock market recovered to its previous high prior to the crash. 

Given they are both investing in stocks, not indexes, I picked up companies with positive revenue growth for this study. 

Guess who made more money?

If you picked Henry, you’re right.

You might find it strange. How can Henry achieve better returns when he bought before the dip as compared to Cindy? The answer lies in the fact that individual stocks can move independently of the index. 

Below is the cumulative revenue growth of those companies between 2008 and 2011:

All of them displayed varying degrees of positive revenue growth. This shows that companies with positive growth could be the ones investors should be buying during bad times. They are not only resilient but also able to possibly provide returns to their investors. 

Companies with deteriorating fundamentals, unfortunately, will not recover so quickly. As investors, we must avoid them. 

When Cindy decided to be out of the market for a certain amount of time, she did not get to enjoy any share price appreciation when good companies reported good results. 

One may argue that we are in a different environment today. Back in 2008/2009, we went through a financial crisis. Today, we are going through monetary tightening. While I agree with this argument, it does not take away the business concept that companies are worth more when their revenue and earnings are increasing. 

One may also argue that I am cherry-picking companies, but isn’t it exactly the role of us as investors to pick good companies? 

According to Hartford Funds, the average length of a bear market is 9.6 months. This bear market could be longer – maybe 12 months or so. I do not know. But I suspect for us individual stock pickers, there are many opportunities waiting for us to pounce on. 

This is why I’m still DCA-ing into individual companies, rather than the stock market indices.

To be clearer, I’m DCA-ing on companies with growth, a strong balance sheet, and attractive valuations.

(DCA refers to dollar-cost averaging. Dollar-cost averaging is investing a fixed amount of money into a particular investment at regular intervals, typically monthly or quarterly.)

Takeaways

• If you’re investing in an index, then macroeconomics plays a very important role as funds flow in and out of an index based on sentiments.
• If you’re investing in individual companies for the long term, their valuations and growth trajectories matter more than the macroeconomic environment.
• Individual stocks can move independently of many indices such as S&P 500 and Dow Jones.
• Be selective of your companies if you want to dollar cost average. Buy high-growth companies with a strong balance sheet and attractive valuations.

Are you experiencing the bear market for the first time in your investing journey? It can be stressful and nerve-wracking to watch your portfolio suffer such huge losses. You may be wondering if you should even be investing now.