Is it time to buy the dip? After all, U.S. stock markets have already had a few encouraging bounces in the past two weeks of trading, though they proved both temporary and more than fully reversible.
Not many would agree with the following answer, as it contends with the common belief that economics, finance and related policies are still at the front seat when it comes to driving price action. At this stage, the market question is closely related to a political and national security calculation associated with Russia’s invasion of Ukraine: Is there an offramp for Vladimir Putin anytime soon? If there is, the occasional bounce could translate into a sustainable longer-term rally. If there isn’t, more unsettling financial market volatility is to be expected.
The top U.S. stock indexes are now down 10% to 18% this year, while widely followed indexes for Europe and emerging markets have fallen 15% and 12%, respectively. The war aggravated what was already an unpleasant start for stock investors into 2022.
Until recently, Buy the Dip was a profitable strategy. What made BTD particularly successful is that markets were consistently supported by huge and predictable injections of liquidity from central banks as well as interest rates pinned near zero. It was so effective that the investor conditioning that came with it made the dips less pronounced and shorter, especially as “FOMO (fear of missing out)” and “there is no alternative” to stocks joined the equation. Data suggest that, during the first week of the war, retail investors were inclined to maintain this approach. But their purchases collided with sales from institutional investors, rendering the strategy less effective in maintaining and building on a short-term bounce. Behind this apparent change is a weakening of the central bank shield that, for too many years, decoupled ever-higher asset prices from fundamentals.
Direct repercussions of the war between Russia and Ukraine.
Traditionally, stagflation has been one of the hardest challenges for policy making. It is compounded because the war in Ukraine came when the Fed had already fallen behind inflation realities and failed to build the much-needed flexibility for its policy responses.
Without an orderly end to the war, the disruptions to commodity markets and supply chains will intensify, as will self-sanctioning by the corporate world; Europe will be pushed into an inflationary recession; China and the U.S. economies will slow notably; some commodity-importing developing countries will risk foreign-exchange and debt crises; and the new stagflationary baseline for the global economy as a whole will be associated with a growing risk of a literal global recession.
Neither economic and financial policies nor markets are well positioned to deal with this combination, let alone overcome it. Without a halt to the atrocities against Ukraine and its people, the global economy and financial markets will face more disruption and as stated earlier, probably, a global recession.
