By Paulina Likos and Tim Lawson, U.S. News & World Report
It’s tough to determine whether the market has hit its bottom, but you can still buy the bear.
When the stock market performs well, investors tend to stick to their investment strategy. But when markets turn chaotic, some may panic and start to sell off their investments. Changes in financial markets are effective at playing with our emotions, but instead of exiting the market, there are ways to take advantage of a market downturn.
Buying the dip is a strategy used to buy stocks when their prices are down, betting that the long-term upward trend will eventually win out. But this strategy is not exclusive to stocks. Investors can buy the dip on any asset class, like commodities, exchange-traded funds and cryptocurrencies.
This strategy is being considered now more than ever, with the Nasdaq and the S&P 500 both in bear market territory.
These big moves can instill fear in investors when they see their portfolio returns going south, but this isn’t the first, nor will it be the last, bear market. Experts say stock market downturns are actually opportunities to continue investing and increase wealth over time.
“It could be a once-in-a-generation opportunity to buy great technology companies on sale.”Nancy Tengler, CEO & CIO
Laffer Tengler Investments.
“It could be a once-in-a-generation opportunity to buy great technology companies on sale,” says Nancy Tengler, CEO and CIO of Laffer Tengler Investments.
Investors wondering about whether it’s a good idea to buy the dip in stocks should keep these concepts in mind:
- Stock market volatility is OK.
- Dollar-cost averaging smooths out fluctuations.
- Invest in quality companies.
Stock Market Volatility Is OK
There are many things that can affect the stock market in the near term. This year, inflation, rising interest rates, the war in Ukraine and COVID-19 lockdowns in China have all been weighing on U.S. stocks. If some or all of these factors persist, the U.S. economy can slow and potentially head into a recession, resulting in the market falling even further.
While the stock market and the economy are not one and the same, they are linked, so economic changes have an impact on stock market performance. One of the factors that has particularly stymied economic growth is inflation.
In response, the Federal Reserve is expected to continue to be more aggressive in its monetary policy by increasing interest rates, which should help ease inflation but also could result in a slowdown in the economy and a hit to earnings.
“The Fed should be able to give people comfort that we’re not looking at inflation at 8% forever. We may not get back to 2%, but over time the rate comes down to something more reasonable,” says Rhys Williams, chief strategist at Spouting Rock.
It’s not all doom and gloom. In the first quarter of 2022, U.S. gross domestic product fell at an annual rate of 1.5%, but the Conference Board recently forecast that U.S. GDP will grow at a 1.9% annual rate in the second quarter. “If you look at the underlying fundamentals, the economy is in good shape, as is the consumer,” Tengler says. “We are in a pretty strong earnings environment, and even with earnings slowing, companies are in solid shape with a lot of cash on their balance sheet,” Tengler adds.
There have been a number of dividend increases in the first quarter as well. “Companies don’t raise their dividends in anticipation of future earnings declines. They have to be able to pay them out of earnings, and are raising them based on their view of the future,” she explains.
Things could get worse before they get better, but it’s likely not much different this time around, which means investors who are patient and stay invested will be rewarded. “Historically, market returns have annualized about 9% since the early 1900s, and that includes the Great Depression and stock market crash and all the bear markets since, because the market tends to go up two-thirds of the time in annual periods,” Tengler says.
Dollar-Cost Averaging Smooths Out Fluctuations
But how do you buy the dip without having to time the market? Rather than putting your cash all in at once, experts say to slowly add in your money over time.
Dollar-cost averaging is investing a set amount of money on a regular basis. Because the investments are spread out evenly over time, investors avoid the pitfalls of emotional investing, which tends to lead people to buy when stock prices are high and sell when they are low.
“If you miss the five best days, beginning with $10,000 in 1980 through the first quarter of this year, your portfolio would be 38% lower than if you had stayed full invested. When you retire, that’s a 38% lower standard of living,” Tengler says.
That’s why she recommends remaining disciplined and continuing to get more shares of great companies at lower prices in periods like this.
“Sometimes you may be early, but in the long term it won’t matter. It’s in the short term where it feels really uncomfortable,” Tengler says.
“Ideally, you get more shares at lower prices, so if you can increase your 401(k) allocation right now, or you can put savings to work, the market may go down another 10%, but three years from now, that’s going to matter little to you,” she adds.
While no one knows when the stock market will recover, history has proven that staying in the market leads to higher returns than trying to time the market.
Invest in Quality Companies
With inflation expected to remain above the Fed’s 2% target, investors who want to reduce risk in their portfolios should consider seeking out stocks with reasonable valuations and whose companies can sustain growth in profitability amid an economic environment of rising costs.
“What you really want in an environment like this is companies that have strong earnings growth, even better if they pay dividends [that] are growing. You want an ability for the company to grow in a reliable manner,” Tengler says.
Since stocks across the board have been down, now can be a good opportunity to buy them at a discount. The “Dogs of the Dow” are good opportunities in this market, says Clark Kendall, president and CEO of Kendall Capital.
Kendall points to Verizon Communications Inc. (VZ), Walgreens Boots Alliance Inc. (WBA), International Business Machines Corp. (IBM), Coca-Cola Co. (KO) and JPMorgan Chase & Co. (JPM) as blue-chip stocks with strong dividends.
Some positive news: While the economy will continue to have some inflation, Kendall says indications point to a healthier, balanced economy emerging. “Generally, the market thinks inflation will come down over the next 18 to 24 months,” he says.