US stocks: analysts spin a line to lure bottom fishers

Is it time to buy the dip? Some fund managers think so.

US stocks suffered another brutal sell-off this week. The S&P 500 index has now fallen nearly a quarter from its January high. Yet for all the talk about a looming recession following the Federal Reserve’s monster 0.75 percentage points interest rate increase, people continue to park their money in American equities.

Investors pumped $14.8bn into US equity funds in the week to June 15, according to EPFR Global data. That marks the sixth consecutive week of gains for the asset class and stood in contrast to an outflow of nearly $9bn from US corporate bond funds.

The urge to bottom-fish is understandable. The “buy the dip” strategy has rewarded investors handsomely in the past. The S&P 500 more than doubled from its March 23, 2020 low during the pandemic to its January 3 high this year. Those who bought at the bottom would still be sitting on a 60 per cent return despite the current rout.

US small caps and value stocks are popular. Funds that invest in those two asset classes received $6.6bn and $5.8bn in inflows this week.

Investors resolve will be tested. The sell-off may still have some way to go. Macroeconomic conditions are quite different from 2020. Then, low interest rates and emergency stimulus programs helped shore up the economy. The flow of cheap money kept valuations of buzzy, lossmaking tech companies sky high.

These days, inflation is at a 40-year high. Stimulus has ended. The Fed has embarked on an aggressive tightening cycle. Interest rates will stay elevated for a while. Corporate profits are under pressure.

Analysts are over optimistic to believe S&P 500 companies will increase average profits by 10 per cent this year, according to Capital IQ data.

Valuations do not yet look cheaper. The S&P 500 is currently trading on 16 times forward earnings, compared with 14 times during the pandemic. Investors should wait for a bigger dip to buy into.