We are currently in a bear market for the tech-heavy Nasdaq and other indices are generally down too. This is prompted by high inflation causing the Fed to plan to raise rates sharply combined with international concerns such as the Ukraine conflict and a weakening Chinese economy hindered by lockdowns. The market is also working to assess how the post-pandemic consumer behaves and process the impact of a stronger dollar.
No Valuation Support Yet
We certainly haven’t reached the point where major indices are close to cheap in historical terms. The S&P 500 trades at around 20x earnings today, or 32x on a CAPE basis, which looks at the average of earnings over the past 10 years.
Neither of those metrics is cheap over the long-term where the average multiple for the S&P 500 whether on a current or CAPE basis is about 15x earnings. Plus remember that’s the historical average, not the historical low which is closer to 5x. However, looking back over the most recent decade, the S&P 500’s valuation seems a little more moderate. As a sanity check, remember that after the recent fall, the S&P 500 is currently only back to where it was in April 2021.
Of course, this valuation data is pretty bearish. If stocks were to revert to longer term averages they could have another 25% or more to fall. Nonetheless, these sort of valuation metrics tend to be more helpful on a long-term view. They imply low returns for investors over the next decade or so, but valuation is less helpful at forecasting shorter term market swings.
Other Metrics Are More Promising
Despite a lack of obvious valuation support, other metrics might be more encouraging. For example, CNN’s Fear and Greed Index is currently in the “extreme fear” category based on return market returns, junk bond spreads and other factors.
This can be a good contrarian indicator. Times when others are fearful can present a buying opportunity. This is because feared events don’t always play out as badly as the crowd expects. The VIX index is also declining from recent highs currently, which may be another positive sign.
Of course, the markets appear concerned about a potential recession. That’s a possibility, but it may not happen and if it did, it may be mild if Q1 GDP data is any guide.
Also, the markets appear to worry about both a potential recession and the Fed raising rates sharply. It is unlikely that both occur. The Fed is watching the economy closely and if a recession seems on the cards, then its likely they would step back from their aggressive plans to raise rates. Hence the markets may see steep rate hikes or a recession, but would be unlucky to see both in parallel.
So, Should You Buy The Dip?
Virtually no one has built an investment career on market timing, since it is no challenging, and whether it works or not extra trading can push up costs and taxes. Buying the dip suggests that you can forecast the markets. It presents dual problems of both when to exit the market and when to get back in.
Given stock markets in the U.S. and many other markets have shown robust returns over history, owning a diversified portfolio of stocks and other assets and investing steadily on a monthly basis can work better than trying to react to market news.