MORGAN STANLEY: The stock market as we know it has been flipped completely upside down - here's how investors should be adjusting their strategies
- A buy-the-dip mentality became ingrained in investor psyches over a long period, helping the stock market recover from tough times on many occasions.
- Morgan Stanley says the previously reliable dip-buying strategy has been exhausted by changing market conditions, like a slowing economy and decelerating profit growth.
- The firm offers alternative trading strategies it says investors should apply instead of continuing to blindly buy the dip.
For much of the almost 10-year bull market, stock investors got excited during times of weakness. That's because any sort of sell-off provided them with an opportunity to buy more exposure at a discounted price.
It was a strategy called "buying the dip," and it worked swimmingly for years. That's largely because the market's underlying sentiment was overwhelmingly positive. Traders found comfort in knowing that, after the selling was complete, corporate fundamentals were strong.
But like all good things, it's come to an end. Now traders are left reassessing a newly uncertain investing landscape - one redefined by higher interest rates and slowing growth.
According to Morgan Stanley, the dip-buying extravaganza officially came to a screeching halt during the stock market's so-called Red October, which saw a wide range of sectors fail to recoup losses as quickly as they once had.
The firm points to the chart below to display this dynamic in action. It shows that buying the dip is at its most futile point since 2002.
This all fits into Morgan Stanley's long-held view that stocks are currently mired in a "rolling bear market" - or a gradual wave of sharp selling that's infecting the market one segment at a time.
"Our view is that the market is sniffing out an earnings recession and a sharp deceleration in economic growth," Mike Wilson, the firm's chief US equity strategist, wrote in a recent note. "The market is speaking loudly that bad news is coming."
Morgan Stanley does note, however, that the rolling bear market it's been decrying for months is actually pretty close to being exhausted, at least from a valuation perspective. But Wilson warns that doesn't necessarily mean stock losses will suddenly subside.
"Now, we must wait for the earnings cuts which will dictate how much more downside is to come," he said.
Given this tricky environment - one that's challenging many established conventions - what's the most prudent next step for investors? Morgan Stanley says to forget buying the dip and try the exact opposite.
To Wilson, that means selling any rallies that transpire going forward and being careful about entering any new long positions.
He points out that while bull markets usually create traps where strong-performing companies look poised for a reversal that never comes, bear markets feature the inverse - weak firms that appear spring-loaded for a rally that never transpires. That makes it even more important to make fully educated stock picks.
"Until we see buying the dip rewarded or earnings for next year reduced to a level that is achievable, we recommend trading like it's a bear market rather than a bull," said Wilson. "If it looks like a bear and trades like a bear, then stop trading it like a bull."