In our Feb Wealth Monthly, we recommended that investors hold off on adding to their US equity holdings. At the time, the S&P 500 Index was down about 7%. Our bias is usually to buy dips, but we felt that the S&P 500 could easily drop another 3-5%. Since last month, the S&P 500 Index has dropped about 4%.
We now think it is likely that US stocks could drop more. We did not expect that Russia would invade Ukraine. We have been cool about US stocks because valuations are stretched, the US Federal Reserve is removing monetary stimulus, and earnings growth is slowing down. The war in Ukraine is an additional headwind for US stocks.
The prices of energy, grains, and many metals have already moved up sharply. Consumers, facing higher food and transportation costs, are going to have to cut back on discretionary spending, and that will reduce economic growth. However, the war in Ukraine has not made us into growling bears. Most of the impact of the war should be in equity valuations already.
This is where we stand. We thought a correction in the US stock market was very possible without the war. As we write today, the S&P 500 Index is down about 11% from it all time high, right at correction level. We think it is okay for investors to nibble at the market here. However, we think that given the economic impact of the war, another 3-4% decline is very possible. That is where we think investors should consider adding more seriously.
When investors decide to buy, they should be looking to purchase stocks that have underperformed. Historically, when stocks rebound off a low, the most beat up stocks, at least initially, rally the most. However, investors should avoid loading up on stocks with no earnings or sky high P/E ratios. If it turns out the market drops more, those stock will likely continue to underperform. Also, although they may outperform initially, it is possible they will run out of gas quickly. Some of the former high flyers will never see their shares recover. Many of the internet stocks of the late 1990s never recovered from the dotcom collapse. Some of the companies