Opinion: 4 reasons to start buying the August stock-market weakness — and what to buy

Investor’s nerves are raw because of all the stock market damage in 2022. Trepidation is understandable. But the current pullback is just a healthy correction in a bull market. This isn’t the “big one.”

Let’s drill down on what experts in these four areas tell us to think about the pullback.

1. No recession ahead

The rise in the 10-year bond yield reflects increasing worries about inflation — and economic growth that just won’t quit. The concern is the Federal Reserve will have to hike interest rates even more, sparking a recession.

However, these worries are unfounded, says Ed Yardeni of Yardeni Research. Inflation is actually pretty tame by now. Yardeni points out that excluding rising rents, the consumer-price index (CPI) and core CPI are 2% and 2.5%. “What am I missing, exactly?” he asks.

Rent inflation is leveling off too, according to data from Zillow and Apartment List. “I know with 100% confidence that rent inflation is coming down. The Fed has basically accomplished its goal,” says Yardeni. He’s referring to the Fed’s desire to bring inflation down to 2% by 2025. “Even if energy prices go up, that will be offset by rents,” says Yardeni. Economic weakness in China will also put downward pressure on U.S. prices.

Another key factor suppressing inflation: Productivity gains. Companies are less likely to pass along input price hikes when they are getting more out of workers because of increased productivity. Productivity jumped 3.7% in the second quarter. This is a volatile time series, but more gains are likely because of huge capital spending by companies looking to cope with rising labor costs. For more details, see my column on this topic.

Meanwhile, the economy should remain resilient despite all the Fed rate hikes, for three reasons.

• The consumer is strong. Their spending is supported by continued jobs and wage gains. Retail sales surged in July, beating forecasts. “Consumption remains very resilient,” says Bank of America economist Michael Gapen.

•  Concerns about a decline in excess savings seem overblown. The baby boomers have $75 trillion in net worth, says Yardeni. They are retiring and spending it. “When they are not playing golf, they are going out to restaurants, traveling, and buying Taylor Swift tickets for their granddaughters. They are spending money,” he says.

•  Fiscal stimulus remains robust. It’s coming from recent laws like the Inflation Reduction Act and The CHIPS and Science Act. “There is so much fiscal stimulus offsetting monetary tightness, we haven’t had a recession. We have never had so much fiscal stimulus before a recession even occurred,” says Yardeni. At 9% of GDP, the U.S. federal budget deficit is the biggest ever outside of wartime, notes Bank of America.

In short, anyone selling stocks now on fears about the long-awaited recession is making a mistake.

Sectors to favor are cyclical areas like industrials, says Yardeni. He also expects a big wave of mergers and acquisitions among banks trying to cope with rising costs linked to more stringent regulations. Yardeni is also bullish on bonds. “Bonds yielding 4.3% look attractive in a world where inflation might still go down to 2%. Over the next 10 years, I don’t think you will regret owning a bond yielding 4.3%.”

Like the technicians below, Yardeni thinks that the stock market may have more downside. He suggests the S&P 500
SPX
could pull back to its 200-day average, which is around 4,150.

But that’s not a given. So, my own take is to begin buying now, and then add on any weakness — if it happens. Yardeni thinks the S&P 500 could hit 4,600 by the end of the year and 5,400 next year, based on moderating inflation, continued economic growth, and corporate earnings strength.

2. Technical analysis: The (upward) trend is your friend

“This is just a technical pullback,” says Vance Howard, who uses technical analysis to manage money in his HCM Tactical Growth fund HCMGX. “We had a fantastic run. To have a 5% pullback is not unreasonable.”

Howard’s system, called the HCM-BuyLine, is a momentum and trend-following model. Howard creates his own index and uses a moving average to tell him if the market is in an uptrend or a downtrend. Right now, the market remains in an uptrend. So, pullbacks are buyable. “The trend in the market is still up and is still strong. This is an opportunity to add some positions.”

He singles out chip stocks like Advanced Micro Devices
AMD,
+0.44%
and Nvidia
NVDA,
-2.43%.
Another way to get exposure to the group is via the iShares Semiconductor exchange-traded fund
SOXX.
He also likes consumer discretionary stocks.

Near-term, Howard thinks stocks could remain weak ahead of The Jackson Hole Economic Policy Symposium, where Fed chair Jerome Powell will speak on Aug. 25, and put in a base after that before moving higher.

Read more about Howard’s system: Beat the market with this quant system that’s very bullish on stocks at record highs

Howard isn’t the only technical analyst who cautions that more near-term weakness may lie ahead. “I don’t think we have hit the bottom in the corrective phase,” says technical analysis veteran Ralph Acampora.  

He thinks the Dow Jones Industrial Average
DJIA
could fall another 3% to 33,500; the S&P 500 could fall another 4.5% to 4,200, and Nasdaq
COMP
could drop another 5.5% to 12,750. “If we get close to those levels, I’d be an aggressive buyer,” he says. “A run back toward the old high for the year is very doable by year-end.”

Like Acampora, technician Larry Williams isn’t buying the pullback just yet. Williams, who melds historical market cycles to create an aggregate cycle that he thinks has predictive capabilities, expects the market to bottom around Sept. 11 or 12. “I think we finish the year very strong. The purveyors of pessimism will one more time bite the dust.”

3. Insiders: Turning more bullish but not there yet

I follow insider buying on a daily basis to get insights on companies, sectors, and the market overall. Lately, I’ve noticed an increase in interesting insider buys – meaning large purchases or buys by insiders with good records.

Composite numbers tell us the same story, but also that insiders have not yet turned outright bullish. This supports the notion that there could be more weakness in this pullback.

* A very short term, one-week Nasdaq stock sell-buy ratio tracked by Vickers Weekly Insider just turned bullish when it fell to 1.59. Below 2 is bullish. But a broader market eight-week ratio has only fallen to 3.62. Not bullish, yet.  

* Data provided by The Washington Service, which tracks insiders for investors, show the same thing. Buy-sell ratios measured by the number of companies and the number of insiders rose in August as the market fell. But both remain below their averages since the start of 2018.

4. Sentiment: Cautious enough to signal a buy

A key part of successful investing is betting against consensus investor sentiment. I use sentiment in the contrarian sense. Be bullish when others are fearful, and be cautious when investors are bullish.

Investor sentiment has improved a lot since I cited extreme pessimism as a reason to buy stocks on Oct. 12, the low for last year.

But sentiment has fallen a lot in August, and it is cautious enough to support the case for buying stocks. If you use just one indicator, make it the Investors Intelligence Bull-Bear ratio. This tracks the sentiment of investment advisers, on a scale of zero to five. By how I use this gauge, investors should turn bullish when this indicator falls below two. In August, the bull-bear ratio fell to 2.36, from 3.07 two weeks before. That’s close enough to tell us sentiment has fallen enough to bet the other way and buy stocks.

Michael Brush is a columnist for MarketWatch. At the time of publication, he owned AMD and NVDA. Brush has suggested AMD and NVDA in his stock newsletter, Brush Up on Stocks. Follow him on X (formerly Twitter) @mbrushstocks.