You Can Pick And Choose Your Dip, So Here’s Three You Might Like

You Can Pick And Choose Your Dip, So Here’s Three You Might Like
Stéphane Renevier, CFA

almost 2 years ago5 mins

  • Tech stocks have already corrected a lot, and the sector could bounce back should inflation and interest rates pressures ease.

  • Healthcare stocks are a defensive way of playing the recovery: their high pricing power and stable demand should help them succeed in a more difficult macro environment.

  • EM $ bonds are offering an incredibly attractive yield right now, and they could be the biggest winner of the three should global growth recover.

Tech stocks have already corrected a lot, and the sector could bounce back should inflation and interest rates pressures ease.

Healthcare stocks are a defensive way of playing the recovery: their high pricing power and stable demand should help them succeed in a more difficult macro environment.

EM $ bonds are offering an incredibly attractive yield right now, and they could be the biggest winner of the three should global growth recover.

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As I said last week, playing defense with your portfolio might be a better strategy than trying to buy the dip given the current economic headwinds. But if you’re really keen on the idea, you can pick and choose where to do it – and there are three particular sectors worth taking a look at.

The opportunistic dip-buying: Tech stocks

Tech stocks have been hammered this year, much more than the broader market. Concerns of higher interest rates seriously damaging record high valuations turned many investors cold on the sector and sent prices sharply lower.

But the tech sector is led by some of the best companies in the world, which have a proven track record of generating strong growth and preserving high margins in lower-growth environments. Now, some effects of higher rates are priced in and recent price action has become supportive: negative momentum is slowing, investor positioning is more balanced, and many stocks are experiencing “triple bottoms”– where stocks repeatedly bounce off their lows before going higher again.

There are still plenty of risks though. Valuations remain very high, further inflationary pressures could force the Fed to be more aggressive, and tech stocks wouldn’t be immune to an economic recession (which is becoming more and more likely). Let’s face it: tech stocks are probably not an absolute bargain right now. But if you’re looking to build a long-term position, you could use this dip as an opportunity to buy into these fast-growing, innovative companies.

And if you liked tech stocks in January, then you might love them now: Meta and Netflix are 43% cheaper, Twitter 22%, Spotify 42%, Microsoft 15%, Apple 13%. Chinese darlings Alibaba and Tencent are trading at a 34% discount each.

If you don’t want to pick individual stocks, the iShares Expanded Tech Sector ETF (ticker: IGM, expense ratio: 0.43%) will give you diversified exposure to the different segments and a significant allocation to all FAANG stocks (most other tech ETFs surprisingly hold only one or two of them). And if you’re after a higher octane (but much riskier) fund, there’s always the ARK Innovation ETF (ticker: ARKK, expense ratio: 0.75%) managed by Cathie Wood. This actively managed fund handpicks the most innovative companies in the world, and it’s trading at a 42% discount to its January price.

Tech stocks are trading at deep discounts to their January prices. Source: Koyfin
Tech stocks are trading at deep discounts to their January prices. Source: Koyfin

The defensive dip-buying: Healthcare stocks

Unlike tech, healthcare stocks are defensive – so they should be relatively resilient to a slowdown in economic growth and inflationary pressure. That’s because healthcare companies have strong pricing power and stable demand (health issues don’t go away with a recession). Plus, the underlying companies tend to be more mature, of higher quality, and provide stable dividends, making them a great asset to own when markets are more volatile.

Healthcare stocks’ valuations are also quite cheap right now – both compared to their own history and the broader market:

Health Care valuations are attractive right now. Source: Goldman Sachs
Health Care valuations are attractive right now. Source: Goldman Sachs

Better still, momentum has just started to turn positive. Healthcare stocks have – so far – remained mostly under the radar. But their recent pickup in performance (beating the S&P 500 by 5% over the last three months) shows that some investors have started to pay attention. If healthcare stocks continue to outperform, they’re likely to grab investors’ attention and lead the next leg of the rally.

That all sounds good, but healthcare stocks are, of course, not risk-free. The main one here is a possible change in legislation to limit the ability of healthcare companies to raise their prices. This is, in fact, why healthcare stocks underperformed the broader market in the second half of last year. But while the mid-term elections this year may introduce some uncertainty, a divided senate will arguably limit the chances that a major reform is passed in the near future.

The Health Care Select Sector SPDR Fund (ticker: XLV, expense ratio: 0.1%) is one of the cheapest options to gain exposure to US healthcare companies.

The global recovery dip-buying: Emerging market bonds quoted in US dollars (EM $ Bonds)

Like it or not, few retail investors would consider EM $ bonds a sexy addition to their portfolio. But after dropping 13% so far this year, they are becoming very much so: EM $ bonds provide investors with a whopping 5% extra yield over US treasuries, and they could lead to even more attractive capital gains should investor sentiment recover. Given the extreme bearishness on EM $ bonds – and the fact that similar yield levels have in the past been followed by strong price gains – the opportunity is getting quite interesting.

What’s more, EM $ bonds are one of the rare EM assets that provide a high income without correspondingly high exposure to local currency risk as the debt is issued in US dollars. And they’ve done surprisingly well in times where the Fed has raised rates. The black line in the chart below shows the additional yield provided by EM $ bonds over US treasuries – a.k.a. the “spread”. Since bond prices go up when spreads go down, a fall in spreads means the bond prices went up. Plus, many EM economies are actually benefiting from higher commodity prices right now, so their performance in this cycle could be even better than it’s been in the past – so long as it doesn’t tip the global economy into recession.

EM dollar bond spreads narrow (their prices rise) when the Fed raises rates. Source: Bloomberg
EM dollar bond spreads narrow (their prices rise) when the Fed raises rates. Source: Bloomberg

Of course, EM $ bonds are not without risk. For starters, if Russia defaults on its bonds, that could put significant downward pressure on prices – although, it’s worth mentioning that Russian bonds account for less than 1% of most EM $ bond indexes. A deterioration in the global macro environment would also reduce the ability of EMs to pay back their debt, pushing spreads higher and prices lower.

The best way to invest in EM $ bonds is to buy the iShares J.P. Morgan USD Emerging Markets Bond ETF (ticker: EMB, expense ratio: 0.39%). This ETF invests in the sovereign debt of more than 30 countries, making it a well-diversified and liquid way to play the view.

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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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