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Trader Theodore Nelson, right, is reflected on a panel as he works on the floor of the New York Stock Exchange Monday, June 4, 2012. The Dow Jones industrial average opened at its lowest level since December after a 275-point sell-off on Friday caused by grim economic signals, especially a dismal report on the U.S. labor market. (Richard Drew/AP)
Trader Theodore Nelson, right, is reflected on a panel as he works on the floor of the New York Stock Exchange Monday, June 4, 2012. The Dow Jones industrial average opened at its lowest level since December after a 275-point sell-off on Friday caused by grim economic signals, especially a dismal report on the U.S. labor market. (Richard Drew/AP)

Is it time to buy this selloff? Add to ...

With the stock market in another rough patch, it’s only natural for investors to wonder whether they should be feeling fearful or greedy right now – that is, whether they should protect themselves from more market turbulence ahead or position themselves for a nice rebound.

What’s interesting is that Canada’s benchmark index has suffered far more than the U.S. benchmark. The S&P/TSX composite index is now in the hole for 2012, by 5.6 per cent. It has fallen 11.4 per cent from its recent February high, but is down 20.9 per cent since April 2011. That means the index is in a bear market, as defined by a drop of 20 per cent or more.

But of course, the S&P 500 isn’t exactly firing on all cylinders either. It has fallen 10.1 per cent since early April, which is the usual definition of a correction. For the year, its gain has shrivelled to just 1.3 per cent (and the blue-chip Dow Jones industrial average is now down 1.1 per cent for the year). The declines have also been broad: Of the 154 industry groups within the S&P 500, only seven groups have risen since the slump began.

So, if dips are the only indicator you want to go by, then stocks are looking attractive right now.

Sentiment also supports taking a brave approach toward the selloff – in that it is awful. Cam Hui at Humble Student of the Markets (via Macronomics) noted that stock-market strategists on Wall Street are unusually wary of stocks right now, which can be good news in a contrarian sort of way. The strategists’ recommended stock allocation is just above 50 per cent right now, down from levels above 60 per cent just a few months ago and close to 2009 lows. When strategists are not keen on stocks, markets can be poised for a rebound.

However, dips and negative sentiment tell only part of the story. Cautious and downright bearish investors also like to bring up the topic of valuation: Sure, the trailing price-to-earnings ratio of the S&P 500 sits at a reasonable 13. However, some observers believe that trailing earnings have been driven by tremendous cost-cutting on the part of companies and soaring profit margins – neither of which is likely to persist.

What’s more, John Hussman has noted that stock market valuations tend to be considerably lower at bear-market troughs, suggesting that today’s valuation can fall more. “Valuations have improved marginally, but the market remains dramatically higher than levels typically associated with run-of-the-mill bear market lows, not to mention secular ones,” he said in his most recent note.

Where does that leave us? Mr. Hussman remains unenthusiastic about stocks. As for Mr. Hui, he sees some parallels with a few of the short-term crises of the 1990s.

“My best wild-eyed-guess is that we will see a major air pocket like 1997 (Asian Crisis) or 1998 (Russia/LTCM Crisis) in which some macro event sparks a major selloff, but turns around based on policy response,” he said. “There are plenty of macro triggers out there. Greece, Spain, China, etc.”

“Don’t misunderstand me. This is not a forecast that stocks are going to plunge this week. Analogues are analogies and they are imperfect. Markets are extremely oversold on a short-term basis and I don’t think that we’ve actually seen the macro trigger for a waterfall decline yet, though there are lots of potential triggers.”

Follow on Twitter: @dberman_ROB

 

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