Essentially, the idea is that short-term weakness related to outside shocks makes for good buying opportunities since strong companies get hit alongside companies that are actually damaged by the shock. So, you can get a good investment on the cheap by buying after a sudden drop.
And this is often true: After most geopolitical-driven drops, stocks end up bouncing back rather quickly.
This time around, it may be different, according to Ajay Rajadhyaksha, head of Macro Research at Barclays. He posed a rhetorical question to himself on whether markets would “rebound soon” in a note to clients Friday. He believed they would not for three reasons:
- It takes time for shocks to fade: “First, markets do not react instantly to momentous events; investors need time to understand ramifications, especially those contingent on policy responses,” said Rajadhyaksha. He compared it to bank stocks after the Bear Stearns collapse, which took several weeks until they stopped falling. While Brexit is less momentous, it will take a similar time period for markets to adjust.
- Stocks are still expensive: “In equities, it is true that the mid-February low turned out to be a good entry point for many equity indices,” said the note. “But these markets today do not offer a similarly attractive entry point.” It is true that price-to earnings ratios still remain elevated, even drawing the attention of the Federal Reserve.
- More political uncertainty: “Investors are likely to worry at least for the next few weeks about new political catalysts, most of which seem weighted to the downside,” said Rajadhyaksha. This is especially interesting given the number of European countries that are considering exits from the EU following Brexit.
For those reasons, it seems to Rajadhyaksha that it may be too early to “buy the dip.” In his opinion, a strong response from the EU that discourages other members of the EU from leaving the bloc would be encouraging for investors. In addition, a drop to slightly lower valuations would help.
Until these factors turn around, investors should stay away from loading up in the market. Or as the title of Rajadhyaksha’s note said, “Don’t be a hero.”
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