Scooping up stocks after pullbacks has been a winning bet for investors over the past decade but some Wall Street strategists are pointing to a multitude of risks that could come with jumping into equities after their latest tumble.
The S&P 500 has notched 25 total pullbacks of at least 5% since the start of 2012, according to Ryan Detrick, chief market strategist at LPL Financial. Over that time, the index has gained more than 240%, bolstering the case for investors willing to step in during episodes of weakness.
Bargain hunting has already been in evidence. The S&P 500 bounced back about 1% since Monday, when a sharp sell-off saw the index end more than 5% below its closing record high, in its biggest drawdown so far in 2021. The buyers included retail investors, who have purchased an average of $1.2 billion in stocks per day so far this week, up from their average, according to Vanda Research.
And JPMorgan strategist Marko Kolanovic on Wednesday wrote that the COVID-19 pandemic was at an "effective end" and urged investors to buy the dip in economically sensitive cyclical shares that would benefit from broad economic improvement.
Others, however, worry that buying the latest dip may come with more near-term risks than before as investors face a bevy of headwinds, from the looming unwind of the Federal Reserve's $120 billion a month government bond-buying program to a protracted battle among lawmakers to raise the U.S. debt ceiling.
Analysts at BofA Global Research on Tuesday cautioned that "the coast appears far from clear" as the Fed prepares to wind down the easy money policies that had helped the market double from last year's lows as early as August. BofA's target on the S&P 500 is 4,250, some 2% below Tuesday's close.
The risks of a more hawkish Fed also concerned analysts at Morgan Stanley, who on Monday said the S&P 500 could fall as much as 20% if the economy and earnings "cool off" as the Fed tightens.
Shawn Snyder, head of investment strategy at Citi US Wealth Management, said a nasty fight among U.S. lawmakers to raise the country's debt ceiling or throw the nation into default is currently the key near-term risk equities face.
"The buy-the-dip strategy still works but there (are) very specific things that are lingering that need to be cleared first," Snyder said.
Additional risks run the gamut from a recent surge in energy prices to worries over the meltdown of heavily indebted Chinese property developer China Evergrande Group. The S&P 500 is up 15.5% so far this year.
Buying the dip has "certainly worked for people over the last 10 years," said JJ Kinahan, chief market strategist at TD Ameritrade in Chicago. However, "at some point things stop working, especially when people do them time after time."
STOCKS IN SEASON?
One scenario outlined by Morgan Stanley's strategists sees the S&P 500 falling by about 10% as the Fed tightens monetary policy due to rising inflationary pressures. In a second scenario, the economy and earnings slow as the Fed tightens, leading to a 20% swoon.
"Bottom line: faster tapering with a greater deceleration in growth implies a greater than 10% correction," Morgan Stanley analysts said.
Despite those worries, however, historical evidence shows that a market powered by strong momentum tends to keep rising. The S&P 500 has notched a positive fourth quarter nearly 80% of the time in years during which it has climbed more than 12.5% in the first nine months, according to LPL's Detrick, delivering a median fourth-quarter gain of 5.2%.
Seasonal trends also could provide reasons to buy sooner rather than later. While September lived up to its historical reputation of being the weakest month with a 4.8% decline, October is traditionally stronger, with the seventh-highest average gains for the S&P 500 since 1950, according to the Stock Trader's Almanac.
November ranks second in monthly performance, with the index rising 1.7% on average, and December third, with equities rising 1.5%, according to the almanac.
JPMorgan's Kolanovic, meanwhile, wrote investors should use the recent pullback as an opportunity to buy emerging and developed market equities with the exception of high-growth and technology shares.