A lot of you have been asking me whether it is time to start buying the dip in 2022.
Now I don’t profess to be 100% correct on this.
And investing is about probabilities and risk-reward.
But simple view – I still think it’s on the early side.
Whatever the case, I will share my thought process in this article.
Whether you agree or disagree with me, just let me know in the comments below!
When will it be time to buy stocks in 2022?
Back in January 2022, this was what I wrote:
I don’t know how long the sell-off [in 2022] would take to play out, but I don’t think this is the bottom…
To me, the bottom will be when the Feds change their mind about rate hikes.
Just watch the Feds in 2022. If they do go “all-in”, so will I. If they hang back, so will I.
When will Feds change their mind…
In my mind, the only 3 possibilities are:
- S&P500 melts down 20-30%
- Treasury (or credit) markets break
- Inflation goes away
Fast forward 4 months.
The framework I set out in January 2022 is still holding true.
But how are the 3 conditions I set out?
S&P500 melts down 20-30%
At current prices, the S&P500 is down 13% from its highs.
For it to fall 20-30% from highs, there could be another 10-20% fall from here.
By this metric, the pain is not over.
Treasury (or credit) markets break
Credit spreads are set out below.
And long story short – despite all the rate hikes being priced into the market, credit spreads are hardly even showing any signs of stress.
Heck, even 2019 had more credit stress than we are seeing right now.
Financial conditions paint a similar story.
Sure, they are slowly starting to tighten – But we are still a long, long way from March 2020 levels.
Inflation goes away
Latest US inflation numbers are set out above.
Very little signs of peaking.
Look under the surface, and the supply chain disruptions from Europe / China, Commodities disruptions from the Ukraine war, none of these seem to be dissipating.
So… Feds won’t change their minds soon?
Using the framework I set out in Jan 2022, it looks like the Feds won’t be turning dovish any time soon.
And therefore… it is too early to buy stocks.
Now if you think the analysis above is too simplistic, I agree with you.
The fact that everyone in the market seems to be thinking the same way as me makes me very, very nervous.
In this business – Only the paranoid survive.
There are 3 key counter-arguments I wanted to discuss:
- Why is Warren Buffet buying?
- Are we at peak rate hike fear?
- Are rate hikes priced in?
Be Greedy when others are Fearful… Why is Warren Buffet Buying?
Despite all the doom and bloom, a very notable contrarian investor has been buying in size.
Warren Buffett’s Berkshire Hathaway bet big on the US stock market in the first quarter, buying $51.1bn of shares, as he put the sprawling conglomerate’s cash pile to work as financial markets slid from record heights.
Warrant Buffet is not buying meme Stocks
Which gets more interesting when you dive deeper.
The 2 big names he bought?
(1) Chevron and (2) Activision Blizzard.
Chevron is an Oil & Gas play.
The fact that he’s buying Chevon, indicates that he thinks the years ahead lie with oil/gas prices that are going to stay elevated.
I mean I share similar views, but that’s not exactly a vote of confidence for those in the “inflation is transitory” camp.
And Activision Blizzard is going to get acquired by Microsoft.
Which makes this a merger arbitrage play, not necessarily a long term view on the earnings of the company.
Read into that what you will, but I’m not so sure if you should see this as a sign that Warren Buffet is necessarily bullish on the market short term.
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Are we at peak inflation?
When the Economist runs a cover like the below – it makes me very nervous.
It makes me wonder whether we are at peak inflation, and peak paranoia about rate hikes.
Charts like the below don’t help.
The worst sell-off in bonds over the last 100 years!
How much worse can things get from here?
Market is not buying peak inflation
But look under the surface.
Over the past month, the S&P500 dropped 300 points and capital markets have been freezing up.
And yet during the same period, markets have raised the probability of 275bps (2.75%) rate hikes in 2022, from 20% to 40%.
While the US Dollar has rallied sharply.
Or in plain English – markets are not buying the peak inflation story.
Market is pricing in accelerating underlying inflation, which will feed into rate hike expectations and USD strength.
Neutral Rates for the real economy =/= Neutral Rates for stocks
That said, I think it is possible that we may be nearing a bottom in bonds/ interest rates.
If you are short it may be time to take profit.
But the distinction that I wanted to make – is that just because long term interest rates may stop going up, doesn’t necessarily mean that it’s time to buy stocks.
The simple reason is that the neutral rates for the economy may not be the neutral rate for stocks.
Think of it this way.
The Feds are going to hike aggressively, and they see us at neutral rates by Sept this year (~2.5%)
The neutral rate is the rate of interest rate at which monetary policy is neither stimulative nor contractive for the real economy.
But, and I think here is the important part – this level of “neutral” interest rates for the real economy, may not be “neutral” for financial assets.
The real economy may still chug along at 2.5% interest rates, but your SaaS stock valued at 80 times sales may not.
So bonds may stop selling off, but it doesn’t mean that stocks will go up.
Are rate hikes “priced in”?
Let’s run some simple numbers.
Higher interest rates will hit stocks valuations.
Let’s say S&P500 PE multiples drop from current levels (18.2x) to where they were in 2015 (15x).
S&P500 forward earnings estimate for 2022 are 233.
So 15 X 233 = 3500 on the S&P500, which is a 17% drop from latest closing price.
What this means, is that if we see a drop in multiples back to 2015 levels (which to me is reasonable given the pace of rate hikes), we may see up to a 17% drop from the latest closing price.
And don’t forget that these are using forward estimates on earnings, which don’t even take into account the slowing economy.
When to start buying stocks in 2022?
All of the above is just a fancy way of saying that I don’t think we are at the bottom for stocks in this cycle.
I still think more pain lies ahead.
Which brings us to the million dollar question – when to buy stocks in 2022?
And the more I think about it, the more I keep coming back to the same answer:
- US Stocks – Buy when the Feds turn dovish
- China Stocks – Buy when you see real action (Fiscal / Monetary Stimulus) instead of just talk
- Singapore – Broadly similar to US, with a close eye on China
When will that be – for US Stocks?
Simple back of the napkin numbers.
A usual bear market plays out over 12 – 18 months
If you assume Nov 2021 was the top of this cycle, we are 6 months into the decline.
But this cycle has been much faster than the previous cycles.
So you accelerate everything, and instead of an 18 month decline you maybe have a 12 month decline.
Which means we *MAY* want to start looking to buy heading into late Q3 / Q4 2022.
No need to get too cute – let the market show you the way
That said, I don’t think there’s a need to get too cute with trying to anticipate the turning point.
We can just watch the market signals.
Sure, you may miss a 5% – 10% rally off the bottom, but it’s still better than buying into a falling market.
What signals to watch?
The key signal to watch for me might be forward hike expectations.
Once I see the forward hike expectations start to drop, that could be an important signal that markets are starting to price in dovishness from the Feds.
Back it up with some macro data, and that could be a big point to watch out for.
I do regular updates on Patreon on such market signals (including when I buy/sell stocks), so you can check it out if you’re keen
This is not like March 2020 – will take time to play out
So far it looks like this bear market will be very different from March 2020.
March 2020 was a very quick decline, followed by insane levels of stimulus, followed by an equally quick recovery.
The major constraint this time around is inflation.
With inflation in play, fiscal and monetary stimulus is limited.
Which means we could be looking at an inflationary bear market.
Which frankly, is a very different beast from March 2020.
In an inflationary bear market, bonds and stocks will drop together. And it takes time to play out.
There are very few real hedges, apart from shorting the market or perhaps stuff like commodities.
Closing Thoughts: If you are long only… just go for a walk… and come back later?
I hate to say it, but if you are a long only investor and cannot short the market, maybe the best thing to do, is to keep elavated cash positions, and just take a walk.
Come back a few months later when all the hawkishness has played out in markets, and look for bargains in the rubble.
You can also check out Patreon for my personal stock watchlist and full portfolio, to see how I am positioned right now and the buys/sells I make.
As always, this article is written on 1 May 2022 and will not be updated going forward. Latest thoughts (and my stock watch and personal portfolio) are available on Patreon.
Love to hear what you think!
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