Why You Should Be Cautious About Buying Stocks Right Now

Why You Should Be Cautious About Buying Stocks Right Now
Stéphane Renevier, CFA

over 1 year ago5 mins

  • There are three reasons why you might want to be cautious about the current rally: the Fed is unlikely to pivot anytime soon, this landing is likely to be anything but soft, and you’ve got much more to lose than to gain by buying now.

  • Plus, market expectations are so high right now and it’s going to be hard for companies to meet them, opening plenty of downside risks should things turn sour.

  • So it’s probably best to stay on the market’s sidelines until we’ve got more clarity on where growth and inflation are heading, or until we’ve got a better entry point.

There are three reasons why you might want to be cautious about the current rally: the Fed is unlikely to pivot anytime soon, this landing is likely to be anything but soft, and you’ve got much more to lose than to gain by buying now.

Plus, market expectations are so high right now and it’s going to be hard for companies to meet them, opening plenty of downside risks should things turn sour.

So it’s probably best to stay on the market’s sidelines until we’ve got more clarity on where growth and inflation are heading, or until we’ve got a better entry point.

Stocks have rallied with a vengeance over the past three weeks, and it’s not hard to see why: second-quarter company earnings ended up better than analysts were expecting, while investors have become more and more confident that US inflation has peaked. But if you’re wondering if it’s time to start shouting about the arrival of a new bull market, you might want to hold off. Here’s why…

The Fed isn’t likely to pivot anytime soon.

The Federal Reserve (the Fed) has two objectives: keep employment near its maximum level, and keep prices stable around 2%. With unemployment in good shape, at a pre-pandemic low of 3.5%, tamping down the country’s high inflation is the Fed’s top priority. And as the central bank’s emphasized several times lately, it’s willing to do whatever it takes to make that happen.

The thing is, inflation did ease a little in July, but it’s unlikely to materially fall unless demand for goods and services craters. It’s why the Fed is hiking so aggressively: it’s looking to slow demand by stifling economic growth with higher interest rates. It’s the kind of situation when good news can actually lead to bad news: if the growth outlook improves (usually we’d say that’s good news), then inflation will likely pop higher again (bad news), which, in turn, would force the Fed to hike rates even higher, even faster (very bad news), until growth stalls enough to slow inflation down.

And no one’s saying it’s going to be easy to bring price pressures down: core inflation – which excludes the more volatile food and energy prices – is likely to remain sticky for some time, and that’ll likely keep inflation from falling to a level where the Fed might comfortably stop hiking.

This landing is likely to be anything but soft.

No matter what the Fed does, there’s no guarantee that it’ll be able to achieve the so-called “soft landing” – tempering growth just enough to bring inflation down, but not so much that it drives the economy into a deep recession. After all, the Fed’s only managed that kind of landing once before.

And there’s a good reason for that: a soft landing requires the perfect amount of slowdown, at the perfect time, and monetary policy – the one tool the Fed’s got – isn’t a precision instrument. It’s a blunt tool that may well deliver the wrong amount of stimulus, at the wrong time. To make things even more difficult for the Fed, the effects of interest rate changes are often felt with a delay of several months. It’s like steering a raft into a rapid with only one paddle, facing backward.

This is important to understand because it could mean that the impact of the Fed’s latest hikes just hasn’t shown up yet in the data. As we explain here, rising interest rates impact different areas of the economy at different times. And if home prices are always the first sector to slow, they’re followed by new orders, companies’ earnings, and finally employment. So the growth slowdown may well be underway, but most of it will hit the economy with a lag of a few months. Given how years of quantitative easing have supported the economy and pushed asset prices higher, I’d be very surprised if a reversal of it just doesn’t matter.

You have much more to lose than to gain.

For stocks to deliver strong returns from here, company profits would have to at least meet expectations. And those expectations are already pretty darn optimistic: investors see earnings growing by about 7-10% over the next two years, profit margins expanding from their already high levels, and inflation dropping as fast as it soared. And, even in the unlikely event that all of that happens, shares likely won’t gain as much as you might think, because those lofty expectations are already partially baked into today’s stock prices.

On the flip side, if things don’t turn out to be as rosy as investors expect – and, as explained, there are plenty of reasons why they might not – stock prices are likely to fall quite a bit to reflect the new reality.

And, remember, losses have a bigger impact on your portfolio than gains. A 100% gain is required to offset a 50% loss, after all, meaning it might take a while for you to make up for those losses. As an example, investors who bought the bear market rally of June 2001 had to wait until April 2006 just to get back to where they started.

Where’s the opportunity then?

If you were itching to buy stocks, then waiting for a bit more clarity on where growth and inflation are heading may be the smart thing to do.

Of course, I may be wrong, and the Fed may pull off a perfect soft landing, and companies' profits may meet the market’s high expectations and stocks may continue to soar. If that’s the case, and you’ve been sitting out this market, then you’ll miss some initial gains. But if I’m right and things do turn sour, then you’d not only avoid the pain of real, actual losses, but you’d also be in a much better position to buy stocks at discounted prices.

As I’ve said many times, there are times to be aggressive, and times to wait for better opportunities. With the macro environment so uncertain and investors’ expectations so optimistic, now is arguably still time for the latter.

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Disclaimer: These articles are provided for information purposes only. Occasionally, an opinion about whether to buy or sell a specific investment may be provided. The content is not intended to be a personal recommendation to buy or sell any financial instrument or product, or to adopt any investment strategy as it is not provided based on an assessment of your investing knowledge and experience, your financial situation or your investment objectives. The value of your investments, and the income derived from them, may go down as well as up. You may not get back all the money that you invest. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment advisor.

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