Whenever there is a pullback, investors watch the market closely in order to try and time their entry into stocks they are following hoping to pick them up at favourable prices. However, when they actually occur, investors get nervous, question their conviction and postpone their purchases. Investors need to remain engaged and patient with the market as a pullback could provide a buying opportunity.
The following are the reasons why we believe investors should buy the pullback:
The hit on growth so far is mediocre given the tariffs already in place. Infact, the International Monetary Fund lowered its 2019 growth forecast for the world’s second-largest economy only by 0.1% from 6.2% from 6.3%. It is also true that the policy stimulus announced so far is sufficient to stabilize growth in 2019/20 despite the recent US tariff hike. No additional policy easing is needed, provided there are no further increases in tariffs or a significant slowdown in growth (which is our base case scenario).
The Trade War
Our base case remains that the U.S. and China will come to some sort of a trade deal by the end of the summer. Assuming a compromise, the details of the deal are less important than removing the cloud of trade uncertainty from the front-page headlines, allowing both consumer and business sentiment to remain strong and support the economy. The June 28-29 G20 meeting in Japan looms large as a potential trigger for progress in negotiations.
The Fed’s U-Turn
Investors have increased bets that the Federal Reserve will cut US interest rates not once but twice this year, to counter concerns about slowing global economic growth that have been inflamed by the worsening US-China trade war. Lower interest rates mean lower borrowing costs for corporates and also further stimulus measures to maintain growth.
US elections next year
It is in Donald Trump’s interest to work towards a deal with China. The last thing that he would want is go for the elections with the US in a recession.
There are many stocks, which are trading on an attractive dividend yield. Additionally, if you look at the spread between the S&P 500 dividend yield (+1.9%) and the 2-year Treasury yield is at the narrowest spread (~6 bps) in two years making equities look more attractive and treasury prices expensive given our base case scenario that we will continue to see global economic growth.
S&P 500 earnings forecasts have stabilized and the consensus has slowly come down to a conservative estimate of $166/EPS for 2019 S&P 500 earnings. More importantly, 2020 earnings are expected to be even better than 2019’s as they notch another record high (current consensus $186). The current
P/E (on 2019 earnings) of 16.75x is relatively attractive given that the 10 year historic P/E multiple of the S&P 500 being 17.75x.
Cash in portfolios
The amount of cash in money market accounts is $3.13 trillion, the highest level year-to-date and the highest since 2010. As that money is deployed and finds its way into the equity market, it should support higher equity prices.
Investors’ Sentiment Indicator
The American Association of Individual Investors’ Bullish Sentiment indicator has fallen to its lowest level since December and the second lowest level over the last two years. Meanwhile, the Bearish Sentiment indicator has skyrocketed to its highest level since January. Historically, sentiment indicators are a contrarian indicator.
President Donald Trump needs to cut a trade deal with China because his re-election prospects rest on keeping the stock market and the economy strong. He cannot afford to let that slip. He knows it. His political advisors know that. A year from now, we can’t be lower on the stock market than we are, and the US economy has to be better. So it’s up to Trump to make a deal.
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