After a brutal January and the three-day rebound of the stock markets at the end of January, investors who believe in buying the dip are ready to pounce like some lion observing prey.
JPMorgan strategist, Marko Kolanovic, expressed their intentions when he said in a statement that “the selloff in the equity market has become overdone. We believe this is the time to buy the dip, especially in small caps and cyclicals.” Following the fact that the beginning of the year has been very volatile, that is easier said than done for several investors.
The S&P 500 has taken its worst beating since March 2020. It shed 5.3% on traders' fears of a Federal Reserve interest rate hike, and the Nasdaq Composite Index, a tech-heavy index, tanked 9%. The markets are so horrific right now.
About 46% of the members of the Nasdaq Composite index have lost about 50% of their 52-week highs, while 76% have lost 20% of their 52-week highs. For example, AMD’s shares dropped 21% while Netflix shed 31%. In addition, Cathie Woods Ark Innovation ETF, which recorded enormous gains in 2020, lost 21%. These results tell a snapshot of the state of the market.
January brought investors and analysts back to reality. It was a significant shakeout for everyone. But JPMorgan’s Kolanovic believes there is too much fear in the market. He cites the fact that there are wholesale drops in share value across the market. In addition, stock markets are in bear territory, and Small-cap stocks are seeing 20-year lows. So the markets are pricing a recession to the full when it hasn't happened.
LPL Financial says that we could see the markets bouncing back in February based on their data analysis. According to their data, when the markets were down in January, the rest of the year was up 62% compared to 86% when January was bullish. The average rally over those 11 months amounted to 13.1%.
So, data like these make the buy-the-dip crowd confident that this is the right time to buy. They believe that stocks are cheap right now, and because they believe there will be a rebound, they encourage people to buy.
It’s like Catching a Falling Knife
Kimberly Woody at Globalt Investments believes otherwise. “Just because a stock has fallen in price and become cheap is not a good reason to buy. On the contrary, this could be a bad reason to buy.”
The buy-the-dip mantra being propagated on Reddit is likened to catching a falling knife. You can get hurt and bleed. For one, no one knows when a plummeting stock will rebound and what the market sentiment will be in March when the Federal Reserve shows its intentions. So, if you buy a cheap stock now, hoping it will rebound, you might end up suffering huge losses.
But if you’re determined to buy the dip, it would be more advisable to buy the dip with a broad stock market. It is more reasonable than buying with riskier assets like meme stocks. This is because the price of a stock reflects a company's fundamentals. For example, its growth potential and dividend. These properties have value no matter the sentiment of the market. So even though a stock price is falling, provided the company’s fundamentals are sound, it will surely rebound.
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