Investors began the new year on a positive note with the S&P/TSX composite index closing at a record high on Jan. 4. However, not long afterward, the positive market momentum faded and reversed course. Less than five weeks later, the S&P/TSX has nosedived over 1,000 points. The stock market selloff has been swift and steep.
But there is a silver lining as panic often creates buying opportunities for long-term investors. This is particularly true when underlying fundamentals are supportive, which appears to be the case right now.
Here are six reasons why this may be an opportune time to buy stocks.
1. The economic backdrop is positive.
Both the Canadian and U.S. economies are expanding at a healthy rate. Last month, the International Monetary Fund raised its growth forecast for the Canadian economy to 2.3 per cent in 2018 from its previous expectation of 2.1 per cent. The IMF has more robust expectations for the U.S., anticipating its economy will expand by 2.7 per cent in 2018.
2. Corporate earnings growth is strong.
The Street is forecasting earnings growth of 23 per cent for the S&P/TSX in 2018. Interest rates, while rising, are still very low, supportive for companies to grow. Furthermore, the U.S. federal corporate tax cut will boost earnings for Canadian companies with U.S. operations.
3. This sell-off has made valuations more compelling.
The S&P/TSX is now trading at a price-to-earnings (P/E) multiple of 13.7 times the 2019 consensus estimate, down from nearly 16 times in late-December, when it was close to its peak. The forward P/E multiple is now well below its three-year historical average of 15.2 times.
4. Many companies have solid balance sheets with some companies benefiting from the U.S. corporate tax cut.
If valuations keep falling, companies may choose to repurchase shares as part of their share buyback programs, and such buying activity may provide support to stock prices. Furthermore, some management teams may seize the opportunity to make acquisitions, using the sell-off as an opportunity to buy companies at low valuations.
5. An oversold market
On Jan. 4, the S&P/TSX closed at a record high and was technically overbought. Since then, the index has fallen over 6 per cent and is now technically in oversold territory. Stocks in the index are trading at more attractive valuations compared with where they were just weeks ago.
6. The 'fear gauge' spikes
The CBOE volatility index, or VIX, commonly used as a stock market fear measure, spiked to 37 on Monday. Looking back over the past five years, the only time the VIX was higher was on Aug. 24, 2015 – the day of the so called "flash crash." On Aug. 28, just four days later, the S&P/TSX had rallied over 800 points or 6 per cent. In other words, buyers returned to the market and the peak in the VIX marked a near-term inflection point.
So what can investors do right now?
I would argue that this is a time for investors to be making a shopping list of stocks to purchase, focusing on companies with strong underlying fundamentals with attributes such as positive sales, earnings and dividend growth, positive earnings revisions, positive earnings surprises and solid guidance for future growth.
Keep in mind that markets often overshoot to the upside when rallying but also overshoot to the downside on weakness. The market is trying to stabilize and may remain volatile until a floor has been firmly established.
An effective investment approach is to stagger your purchases once the market begins to show signs of stabilization. That way, if there is further downside in the future, you can accumulate more shares – never invest your money all at once. During this time of market volatility, make a list of stocks that you want to own within a well-diversified portfolio.
Investing icon Warren Buffett relates investing in the stock market to baseball saying, "The trick in investing is just to sit there and watch pitch after pitch go by and wait for the one right in your sweet spot."
So construct an investment plan, set your target prices, and get ready to take action. For many stocks, a sweet spot may be approaching.