Investors have the right to buy the dip

Renco van Schie of Valuedge does not suffer from recession fears. “For me, the glass is more than half full right now.”

In May, fears of high inflation turned into fears of a recession. Investments began to increasingly price in the risk of a recession. Media attention to the word recession exploded. Last week, after the publication of the negative GDP figure for the second quarter, we received confirmation that the US economy is in a technical recession.

Formally, a recession in the United States is identified by the National Bureau of Economic Research (NBER), and it looks at more than just economic growth. The NBER’s ruling has not yet been published. The market is starting to debate whether this is officially a recession because the last two quarters have seen some economic pain. It shows the recession obsession that currently exists.

Estimate financial pain

I try not to get too involved in speculation about an (imminent) recession, but I do estimate potential financial pain that could cause long-term damage. Rising unemployment, falling incomes and falling corporate profits are symptoms of the economic pain.

The first two elements have so far not been visible, but falling growth indicators should cause companies’ profits to plummet, is the general opinion. If earnings start to fall, it also means that stock valuations, down 30% this year, aren’t as attractive as they seem. This justifies the negative view that stocks will fall much further.

Big numbers

We are now more than two weeks into the corporate earnings reporting season. The global picture so far is that both revenue and profit for the second quarter are better than expected. This indicates underlying financial strength. Most consumers and businesses are still spending a lot of money. Money that is abundantly available due to the strong growth in the money supply during the corona crisis.

Even more positively, most companies do not present a gloomy outlook. As a result, earnings expectations for the market as a whole are only marginally revised down for 2022 and 2023. Dividends and share buybacks are not under pressure. Some large companies, synonymous with market health, have even raised their expectations (e.g. Microsoft, Amazon, Unilever, LVMH).

“Dividends and share buybacks are not under pressure”

Investors buy the dip

The much lower valuations suddenly look very interesting with stable earnings expectations. Investors have therefore started to buy the dive. Many stock markets found support in July at levels before the start of the coronavirus pandemic and have begun to recover in recent weeks.

At the end of last week, nearly 60% of stocks in the S&P500 index hit a 20-day high. This points to improving conditions, and historically stocks rose in the 12 months following such a signal.

Last time this happened? Shortly after the corona crash and the beginning of January 2019 after the big Christmas sale. The graph above shows the large increases in the following year.

More optimistic positioning

I read many comments that the market is recovering from misplaced optimism. Any data that doesn’t support the recession view is dismissed as “it was better than expected, but it’s sure to get worse from here”. I think this is a dangerous attitude. Admittedly, the world is experiencing a lot of uncertainty at the moment, but this has already made the mood very bad.

A year ago the mood was euphoric, investor valuations and positioning high and cash levels very low. Now we are in the opposite situation. With all the negativity and doom prevailing at the moment, I choose to look at developments with a flexible and nuanced eye.

For me, the glass is more than half full at the moment, and we have translated that into a more optimistic positioning of the portfolios in recent months.

Renco van Schie is co-founder and chief investment officer at the asset manager Valuedge. The information in his articles is not intended as professional investment advice or as a recommendation to make certain investments.

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