The market correction: buy on the dips?

Eric Roseman - Wed 07 Jun, 2006

...The market correction...One of Wall Street's favourite investment strategies is to buy stocks following a dip or decline in values. And who can argue with this strategy - especially when examining the successful track record during the booming 1990s?..In every correction from 1994 to 1999, US stocks were bid substantially higher 12 months later...

Buy on the dips or run for the hills?

One of Wall Street's favourite investment strategies is to buy stocks following a dip or decline in values. And who can argue with this strategy - especially when examining the successful track record during the booming 1990s?

In every correction from 1994 to 1999, US stocks were bid substantially higher 12 months later. In fact, the 1990s were home to the best ten-year stretch of stock market profits for the Dow Jones Industrials Average since its creation in 1896.

But it's certainly another story altogether in the 21st century.

Since stocks peaked in 2000, investors in industrialized economies have not earned a single penny in profits. Embracing a "buying on the dips" strategy literally destroyed vast fortunes starting in March 2000, especially for technology and telecommunication stocks. Six years later, the NASDAQ is more than 55% off its all-time high while major market bourses are flat. If an investor aggressively purchased stocks in 2000 and 2001, he would still be sitting on losses in 2006.

In May, the MSCI World Index, a market-capitalized benchmark tracking the world's industrialized stock markets since 1969, declined 3.7% - its worst monthly loss since April 2005. The S&P 500 Index also lost momentum in May, declining 3%. But major market declines were pale next to the beating recorded by developing bourses.

Emerging markets, the rage among investors since late 2002 and already up more than 190% since September 2002, plunged 11%. And India, the hottest market among fund circles and investment conferences lately, just tanked 12%. From its all-time high on May 10, the Mumbai Sensex Index has collapsed 22%.

With broad-based market declines since mid-May, is this the time to add or purchase new stock market positions?

With the exception of some incredible values among large-cap blue-chips and Mainland Chinese equities - where we remain very bullish - the majority of world markets still offer poor values. Interest rates are still rising in the United States, Europe and soon, even Japan. Corporate earnings are also likely to face a major downgrade this summer following soaring input costs as commodities hit the roof.

Plus, US housing has clearly peaked, encouraging slower domestic consumption there. Consumption is a major part of the American economy where 65% of GDP (gross domestic product) is derived from the ever- spendthrift consumer, already in their eyeballs with mortgage-backed debt.    

Compared to previous monthly declines of similar magnitude since the bear market low of October 2002, this decline is far more significant. That's because they are already late in the credit cycle in the United States where mortgage-financing costs have increased, home-loan default rates are rising and the odds of a major systemic event occurring continue to rise by the day. Since 1973, there has never been a Federal Reserve tightening cycle that didn't end badly.

I'm not forecasting a bear market – yet... risk is rising in mid-2006. Investors should stick to high- quality global stocks and equity funds, selective commodities and currencies.

Bargain-hunting amid a severe correction is a bad idea. Stay liquid and make sure you hold a diversified portfolio of investments.


Regards,

Eric Roseman
for The Daily Reckoning