Throughout the post-financial crisis bull market, ‘buying the dip’ was broadly a successful investment strategy as markets tended to go on to rally past their previous high but BlackRock has avoided doing this during the most recent sell-off. 
On the back of concerns such as stronger-than-expected inflation, interest rate hikes from central banks around the world and the war between Russia and Ukraine, markets have been falling over 2022 so far.
The US stock market, for example, has suffered its biggest year-to-date losses since at least the 1960s, prompting some calls to ‘buy the dip’. However, strategists at the BlackRock Investment Institute said: “We pass, for now.”
They gave three reasons for this call.
The first is that the fund management house is concerned about an increased risk that profit margins will decline as companies deal with high energy and labor costs. However, the market’s consensus earnings estimates don’t appear to reflect this – Refinitiv data shows that analysts expect S&P 500 companies to increase profits by 10.5% in 2022.
“That’s way too optimistic, in our view,” BlackRock’s strategists said. “Stocks could slide further if margin pressures increase.”
S&P 500 operating margin, 2000-2022
Source: BlackRock Investment Institute, S&P
Another reason for not buying the dip is the growing risk that the Federal Reserve tightens policy too much in its effort to curb inflation or even just that the market starts to act like it will.
The higher-than-expected US inflation print that was published last week, where CPI rose by 8.6% versus economists’ expectations of 8.3%, could increase the risk of the market over-reacting.
“That’s all part of why we turned tactically neutral on equities last month,” BlackRock said. “Stocks slumped last week near lows of the year. We don’t see a sustained rally until the Fed explicitly acknowledges the high costs to growth and jobs if it raises rates too high. That would be a signal to us to turn positive on equities again tactically.”
That said, the firm does think the Fed will eventually come round to living with higher inflation instead of raising rates to the point where the growth is snuffed out. However, at the moment it is uncertain when the central bank will change course and put rate hikes on pause, contributing to BlackRock’s short-term caution on stocks.
Finally, the investment management house argued that stocks don’t look much cheaper than before 2022’s sell-off, adding another reason to avoid rotating back to equities during the current dip.
“Equities haven’t cheapened that much, in our view,” its strategists finished. “Why? Valuations haven’t really improved after accounting for a lower earnings outlook and a faster expected pace of rate rises. The prospect of even higher rates is increasing the expected discount rate. Higher discount rates make future cash flows less attractive.”
The BlackRock Investment Institute is currently neutral on stocks on a six- to 12-month horizon, although it remains positive on equities on a long-term, strategic view.