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Overheated markets: time to buy the dips?
2021-11-08 • Updated
If we look back at the previous year, we will remember the amount of fear that gripped us when the black swan, Covid-19, appeared. It was especially visible in the performance of the US stock market. In February, S&P500 dropped from the all-time high at $3 397 to the levels around $2 270. At the same time, NASDAQ corrected by 32% from the high of $9 760. While market newbies were affected by this storm, smart people started to "buy the dips" and await further momentum. The market did not make them wait forever. After the Fed and other major central banks began to pump cash into the economy and implement loose monetary policy, the demand for the risky assets increased. As a result, the indexes retested their highest levels in the middle of 2020. The end of the year was driven by the optimistic news on vaccine distribution and the US election's outcome. Since then, S&P and NASDAQ have been reaching new peaks almost every month.
As natural as it is, a bullish market attracts everyone. However, if you are familiar with Benjamin Graham’s works, you know how dangerous the market euphoria is. The worrying signals have already appeared. According to Bloomberg, an average of 15.8 billion shares have traded daily over the past 20 days. This is the highest spike in volatility since last year's sell-off at the start of the pandemic. Some people see this market frenzy as speculation that does not have any fundamental bias. So, what should we expect: a crash of the market or just a short-term correction?
Buying opportunity is coming?
Most analysts don't expect a pop of the market bubble soon, but they confirm that a 10-20% correction to the current highs is an inevitable scenario. They note that the current bullish ride is driven by earnings growth, which is torn off market-based fundamentals. Additionally, vaccine-related optimism may lead central banks to monetary policy tightening, limiting cash in the economy. However, the chances of this event happening soon are very low.
The Bank of America expects a 5-10% correction as soon as in April. According to the bank, investors should not be afraid of the slump, as it will provide a buying opportunity. Analysts from Jefferies Group have a similar opinion. They anticipate 2021 to be “at best a flat year” for stocks.
What should you do?
A long-term trader may wait for the correction to buy cheaper stocks and indices. If you are a swing trader or an intraday trader, then you just need to stay calm, follow the daily news, track risk sentiment, and don't forget about money management. This way, market swings won't affect you.
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