Buy the dip?

One of the major risk factors that we’ve repeatedly been highlighting since last year is a possible contagion resulting from a recession and a bear market in the United States.

During the past few weeks, global markets suffered from heightened volatility as there were increasing signs that the United States was indeed heading into a recession.

For example, the US Bureau of Labor Statistics recently disclosed that employers hired a total of 114,000 workers in July, well below consensus expectations of 185,000. The unemployment rate also climbed further to 4.3 percent, triggering another recession indicator known as the “Sahm Rule.” The Sahm rule states that a recession is underway once the three-month moving average unemployment rate is 0.5 percent above its low during the past 12 months.

Aggravating the situation was Bank of Japan’s decision to raise short-term interest rates to 0.25 percent from zero percent to 0.1 percent on July 31. Coupled with expectations that interest rates in the United States would start to go down soon, this acted as the catalyst for the yen to appreciate significantly by more than 10 percent in the span of only a few weeks. Consequently, the yen carry trade began to unwind, hastening the speed and magnitude of US stocks’ decline.

Last week, the Nasdaq and S&P 500 indices were down 13.1 percent and 8.5 percent, respectively, from their recent highs. Meanwhile, Japan’s Nikkei 225 fell by as much as 25.5 percent, erasing all its gains for 2024. Here at home, the Philippine Stock Exchange Index (PSEi) was lower by 3.8 percent from its July peak of 6,689.37.

After the sharp decline, stocks are now rallying. This is causing many investors to wonder if the recent sell-off is an opportunity to “buy the dip.” After all, the Fed is now expected to cut rates more aggressively, with the market pricing in a possible 100 basis points worth of rate cuts by the end of the year.

While it might be tempting to hunt for bargains, we remain concerned.

Although more aggressive rate cuts by the Fed is good news, rate cuts (like rate hikes) take time to work. This is why during past rate cutting cycles, the US economy continued to weaken, and the stock market continued to fall, despite lower interest rates.

Moreover, even though US stocks fell sharply the past few weeks, the S&P 500 is still trading at 21.1X price to earnings ratio (P/E), significantly higher than its 10-year historical average P/E of 18.2X.

In fact, given the heightened risk of contagion if indeed the United States suffers from a recession and a bear market, investors who are still heavily invested in the stock market or are uncomfortable about the size of their exposure should instead take advantage of the ongoing rally to pare down or sell some stocks.

That said, investors should remain optimistic as a sell-off caused by contagion is an opportunity to buy local stocks at even cheaper prices. After all, the Philippines is a domestically driven economy that is less vulnerable to a US recession.

Moreover, domestically listed companies are fundamentally strong, with manageable debt levels and liquid balance sheets, minimizing their risk of bankruptcy.

Finally, since the Philippine market has merely moved sideways the past few years despite companies’ improving profitability, valuations of stocks have become very attractive, with the PSEi trading significantly below its historical average P/E ratio.

As such, investors who have cash should mentally prepare to deploy those funds in case stocks are sold down because of contagion.