- Retail investors have been buying the dip as professional investors sit out this round
- Longer term prospects for U.S. equities looks good nevertheless, against a backdrop of strong economic growth and robust corporate earnings
The benchmark Dow Jones Industrial Average has now fallen for four straight weeks, and the VIX, the “fear index” has reached 32, near the highest it’s been in a year.
With trouble everywhere, getting a grip as to who’s doing what in the stock market is hard, but one overarching trend that took shape over the past week is that professional traders, while keeping a hand in for picking up gems, are taking a broader step back as retail investors kept the money flowing.
According to a report by Goldman Sachs Group’s (-1.06%) prime brokerage, over the past three days of last week, as Russian shells rained down on Ukrainian cities, hedge fund clients unwound risk at the fastest rate in three months in cumulative dollar terms while retail traders “bought the dip” with US$4.1 billion flowing into S&P 500-lined ETFs.
While retail flows have been increasingly significant in U.S. markets ever since the onset of the pandemic, being held to blame for the meme stock frenzy in early 2021, mom-and-pop investors have also provided some cushion for markets that would otherwise have corrected far more sharply.
Views on the market typically diverge even under regularly quiet market conditions, but a slew of contradictory factors are making the “fog of war” difficult to see through with investors having to contend with the continued Russian invasion of Ukraine against the prospect of U.S. Federal Reserve monetary policy tightening.
The conflicting factors are even confusing the world’s smartest computers with UBS Group’s machine learning model predicting that depending on how the Russian invasion of Ukraine resolves itself, the S&P 500 could end anywhere between 3,800 to 4,800 – a whopping 26% range.
At this rate, investors could be better off training a monkey to throw darts at a financial newspaper to determine which stocks to buy or sell.
Making matters worse, central banks are having to deal with high inflation, especially energy prices, slowing growth – raising interest rates too aggressively at this critical juncture could easily throw their economies into recession, and trigger stagflation (slow or negative growth and high inflation), something that no policymaker wants to have on their hands.
Investors wondering what to do next should note that even though stocks may be able to weather geopolitical crises, even war, they aren’t immune to recessions.
For now, the bull case for American equities remains intact – solid economic growth continues to be expected throughout this year and next, even as higher energy costs compress margins, and earnings for corporate America look to be robust.
And while the raging war in Ukraine has dampened appetite for European equities, it’s actually helped to drive demand for U.S. stocks, solidifying the America First trade.
With the volatility sending the average stock in the S&P 500 below its 10-year average price-earnings ratio, falling U.S. Treasury yields, on demand for safe havens, could point to favorable valuations for U.S. equities.
Moreover, history shows that the market impact from military events, while significant in the short run, is typically fleeting.
What’s most crucial is that central bankers don’t make any significant policy missteps that could push the U.S. economy into a recession and investors can keep calm and carry on.
