Market Correction – buy the dip? Why it might be too early
6 August 2024
Financial Market in correction mode
Led by recession fears
Spike in volatility
Buy the dip – not yet!
Forced reduction of risky assets will lead to more price pressure
Slow investment process in big investment houses
More price pressure could therefore be ahead
Follow markets closely - buying opportunity around the corner
My Portfolio: Profit taking on short positions (reduced or closed during the last 2 trading days) as well as long volatility trade. Furthermore, took profit on long-term US Treasuries. Short-term trading stocks automatically sold mainly with profit through limit orders when market correction started.
Wait on the sideline to buy and add more equity exposure
All of a sudden and maybe for many as a surprise, financial markets are in a sharp correction mode. Almost out of the blue market sentiment changed dramatically, switched completely from euphoria and speculation which was led by the tech sector and supported by the outlook for potential rate cuts by major central banks.
Last week, some released figures about the US job market which were below market consensus estimates shifted investors market view completely in no time. Now, fears of a potential US recession are back on the cards which led to panic selling and a slump among global equity markets. At the same time investors looked for safe haven assets like Swiss franc currency and Japanese yen as well as US Treasuries. Within one week, the yield of the US 10-year Treasury fell from around 4.3% down to almost 3.7%.
Volatility – spike after a long period of lower level
With equity markets climbing from highs to new record highs, volatility remained for longer on low levels. Volatility indicates the level of market uncertainties. The last days, market volatility like the VIX Index saw a big spike reaching much higher levels than last time seen during the banking crisis in March 2023.
Volatility VIX Index (1 Year)
as of 6 August 2024
Source: TradingView 06.08.2024
Opportunity to buy the dip?
In my view, not yet. Markets could try now to stabilize and even rebound. However, after such a spike in volatility during recent market turmoil, big investment houses and pension funds will be forced to react in case the volatility remains on elevated level for a certain period.
Volatility is a measure of risk and is the factor which impacts the level of risk budget in a portfolio. With low volatility, which indicates market swings to be within rather narrow bandwidths, a portfolio receives more risk budget and therefore contains more risky assets. In contrary, high volatility reduces the available risk budget for a portfolio. This means, that the portfolio manager is forced to reduce the stake of risky assets.
Based on this factor of the portfolio management theory, big financial institutions could be now confronted with lower risk budget, why they are forced to reduce portion of their risky assets like equities, to adapt their portfolio allocations to the new market environment.
As the set-up of their investment processes are not that flexible and therefore rather slow, this has not been implemented yet and is going to happen during the coming days. Therefore, equity indices incl. the crowded positions might see some more price pressure in the following days.
In case this reduction leads to a second wave of bigger down moves similar we have seen during the last days, this could even trigger breaches of technical levels and forced selling by margin calls. Leveraged investors are then forced to sell positions immediately to cover their negative account balances, no matter of a potential rebound. In case of such moves and wash out, this is mainly the best indicator and time to increase allocation in equities.
Furthermore, it is important to keep more factors in mind which could impact markets on a short-term basis. Uncertainties remain with a risk of escalation in the Middle East conflict which would definitely have short-term market impact. Swings between recession fears and optimism could continue which would keep volatility on elevated level.
The next release of inflation data and the steps of central banks will be monitored closely by all investors. I do not believe that the central banks, mainly the Fed, kick in with extra measures to stabilize markets.
My Portfolio
As already highlighted in several publications on ETFMandate during the latest months, I expected and marked an alerted stance for a market correction to be around the corner. As mentioned, the time and day of such an event is hard to predict in such a speculative market environment. However, it is important to be well prepared on such events. This can be an effective way to relative easily avoid big short-term losses in the portfolio. I am wondering how many financial institutions took measures or advised their clients for such a case which could relatively be well expected.
My Investment Calls on US Tech stocks
Chart Nasdaq Composite Index
since 07/2022 - 06.08.2024
Source: TradingView 06.08.2024
After taking profit during the highs in March and April on the Tech sector, I waited with a cash pile on the sideline and advised to wait with regaining more exposure in equities since. Even after the correction in European equities it was not a the time to buy equities as mentioned in my last article.
With markets turning into high speculative mode during May and June, I started to build up short positions mainly on Artificial Intelligence (AI) related stocks and health care stocks which were recently driven by the crowd, based on the weight loss topic.
In addition, I added ETFs to be short on the semiconductor sector (betting on decreasing prices) and long on volatility (betting on rising market uncertainties). All the gains from these positions supported my portfolio to go quite stable during this phase of panic and market slump in recent days.
Furthermore, with the decrease and rather overshooting of the long-term interest rates, I decided to sell and take profit on the allocation of long-term US Treasuries.
Now it is time to follow markets closely as there is an opportunity around the corner to buy stocks on a lower level again. The sentiment index I monitor closely in such cases is on “extreme fear” level, which already indicates a buy signal, usually a good entry point. However, extreme fear levels can last longer and as mentioned above, price pressure could continue for some more days.
Disclosure of shares in my portfolio specifically mentioned in this article (as of 6 August 2024):
No specific disclosure as all holdings are mentioned in this article already