Buy the Dips AND Sell the Rips?

March certainly did not disappoint. Right on cue, it delivered the much-anticipated correction we wrote about in last month’s newsletter. It was long overdue and the Magnificent Seven stocks were getting ridiculously overpriced. The correction was swift and size-able. The S&P 500 index has now retreated almost 10% from its mid-February highs (as of the closing today), while approximately $7 trillion of paper market value has been erased from portfolio balances.

While no one enjoys seeing their account balance decline, such corrections are not only normal but useful too. They take away some of the excess speculative froth from the market, bringing valuations to more reasonable and sustainable levels, presenting investors with better entry points to deploy capital. In other words, corrections usher a sales event for investors. The question is should they “Buy the Dip”?

The answer depends on what causes the correction, how deep the dip is, and what the investment horizon of investors is. If the cause is transitory, causing no sustained harm to the economy, the price drop is enticing enough, and the investment horizon is more than a year or two, then “Buy the Dip” might make sense to investors. Alternatively, if recent events are expected to cause prolonged harm to the economy, the price drop is not enticing enough, and investors need access to their funds soon, then they may not perceive the correction as a buying opportunity. Instead, they may wait for a price bounce up to use it as an exit point, and “Sell the Rip”.

Since funds invested in the stock market have presumably a long-term horizon, we turn our attention to the causes of the correction and their possible effects on the economy. Investors are bombarded daily with media stories about Elon Musk’s DOGE (Department of Government Efficiency) discoveries of waste and fraud in government accounts, as well as the upcoming tariffs as the main causes for the market correction. Frankly, either one by itself can increase uncertainty and cause a market correction. Both of them together could shake consumer sentiment and business confidence and possibly cause a recession.

The DOGE has already identified $150 billion of wasteful or fraudulent government spending and believes it can identify, and most importantly block, up to $1 trillion of such government transfer payments. Whether these are payments to well-connected NGOs (non-governmental organizations) with untraceable spending, or Social Security, Disability, and Medicare payments to recipients using millions of dead people’s Social Security numbers, these government payments will be eliminated as they should. No problem there. The concern of course is that if up to $1 trillion of government spending is eventually removed from the economy, it would slow down economic activity, possibly pushing the US economy into a recession. However, in that case we would expect the FED (Federal Reserve) to intervene, adding liquidity to the banking system, lowering interest rates, and helping the US economy avoid a recession.

But what if the FED cannot intervene because inflation is not close to the 2% FED target? The inflation data released last week had the February PCE (personal consumption expenditures) price index at an annualized rate of 2.5% (same as January), but the Core PCE price index (excludes food and energy) at 2.8% (higher than January’s 2.7%). That’s where the tariffs concern comes in. These inflation data were for February, a month before the US government enacted tariffs on Mexican, Canadian, and Chinese goods. More tariffs are expected in April, which will include Europe and possibly other parts of the world. Since tariffs are taxes on imported goods, as they are applied to more products imported from more countries, it is reasonable to expect the March and April PCE data may show a higher inflation rate. This could put the brakes on whatever monetary policy relief the FED could provide to a slowing US economy.

Reality of course is more complicated, as the economy is a dynamic system and not a static one. In simpler terms, a slower economy resulting from lower consumer spending and business investment could restrain future price increases, so the ultimate effect on inflation and FED actions remains to be seen.

Furthermore, during the first Trump administration (2017) President Trump enacted tariffs on trading partners not as a permanent measure, but as a negotiating tool to extract concessions from them. The policy worked well and by 2018 the inflation rate was lower than in 2017. It is reasonable to assume the same strategy is employed this time around. For instance, the 25% tariffs imposed on Mexico and Canada could be reduced or eliminated if they spend the resources to guard their border with the US in order to stop the flow of drugs into the US. The 20% tariffs imposed on China could be reduced or eliminated if the Chinese government agreed to the sale of social media app TikTok to a US company (for national security purposes) and agreed to open manufacturing plants in the US (to reduce the US trade deficit with China). It remains to be seen which of the trading partners are willing to engage in these negotiations. Mexico seems to be engaging. Canada is not, perhaps due to the upcoming Canadian elections. Presumably negotiations with China are under way and Presidents Trump and Xi have both agreed to meet in person in June. Such in-person meetings are scheduled only if there are major agreements to be announced. Until then, as Treasury Secretary Bessent said, we should expect some turbulence over the next 6 to 12 months.

There are, however, a couple of other economic concerns that don’t seem to get enough media coverage, yet they provide context on how much the US government can reduce its spending and how long it can play a game of chicken with tariffs, before economic conditions deteriorate to the point it is forced to blink.

First is the deteriorating position of the US consumer. Consumer spending constitutes a little over 70% of US output. At the end of 2024, the US household debt stood at $18 trillion. About $13 trillion was housing loans and $5 trillion was consumer loans. The consumer loans include $1.66 trillion in auto loans (4.8% delinquency of 90+ days), $1.61 trillion in student loans (9% delinquency rate), $1.21 trillion in credit card loans (11.4% delinquency rate), and $0.5 trillion in all other loan categories. These delinquency rates are typically seen during recessions, so the question is how long can consumer spending support corporate profits and keep the economy growing?

Second is the health of the housing sector. Housing affects multiple sectors of economic activity like construction, materials, appliances, financing, realtor services etc. Yet the US housing remains in stagnation. During each of 2023 and 2024 we had only 4 million existing home sales, the same low level we had in 2012, coming out of the Great Financial Crisis (GFC). Meanwhile, the majority of the $13 trillion in housing debt is guaranteed by the government agencies Fannie Mae and Freddie Mac, which make mortgage loans more available and at lower mortgage rates (loans guaranteed by government agencies). The new administration, however, intends to privatize these two agencies, which could reduce availability of mortgage loans and cause loan rates to shoot up, irrespective of FED actions.

At the same time, recently released data reveal that about 400,000 housing units are about to go through foreclosure proceedings, adding to the housing supply for sale. These properties were supposed to be foreclosed last year, but since it was an election year the proceedings were “delayed” for obvious reasons. The point is the higher supply of housing units for sale should put downward pressure on housing prices. Good for potential buyers, bad for homeowners whose personal wealth is based on high house prices. But how high are house prices anyway?

Comparing the aggregate value of all housing units in the US at the end of 2024 with the US GDP of the same time we get 167% ($49.7 trillion / $29.7 trillion). The same comparison at the end of 2006 yields 167% ($23 trillion / $13.7 trillion). In other words, housing prices relative to US income are currently at the same level they were at the top of the worst housing bubble in US history, and just a few months before the bubble burst. Given these housing valuations, will the 400,000 additional existing homes for sale coming this year, and the privatization of Fannie Mae and Freddie Mac cause another housing crisis?

Despite the economic concerns described above (possible lower government spending, possible higher inflation induced by tariffs, possible weaker consumer spending, and possible housing bust) the S&P 500 index has corrected by only about 10%. To put things into context, the index is currently at the same level it was 8 months ago, in July 2024, when investor optimism reigned supreme and pushed the Index to the 5,500 level for the first time. So, if investor sentiment has soured, why not correct more?

While it is possible the correction could continue some more, it is useful to notice that all economic concerns listed above are preceded by the adjective “possible.” It is impossible, however, to know at this point whether all or any of them will materialize. It is entirely possible, for instance, that trade deals will ensue, and we may avoid widespread tariff implementation and inflation. It is also possible that new manufacturing plants will create enough private sector jobs to offset some of the loss of government jobs. It is also possible for the government to introduce new tax cuts and the FED to lower interest rates more than the expected two times this year, which will boost consumer spending and support the housing market. So, if some or all these economic concerns fade away, not only we may avoid a recession, but the market may have a face ripping rally.

Given the need for the government to control its debt and the dual mandate of the FED to promote employment and control inflation, it seems very likely we are in a period of policy stop-and-go, stimulate-restrain, inflation-disinflation. In such an environment, passive buy-and-hold strategies may not work well. Instead, more active getting in-and-out of positions may do much better. In other words, it seems the market may be in for a period of “Buying the Dips” AND “Selling the Rips”, until we get more clarity of the economic picture. We are fine with that. Positions should enter the portfolio when they represent good value. Once prices rise, valuations become stretched, and the positions do not represent good value anymore. These positions should exit the portfolio at that time. Indeed, this represents our investment management philosophy.

While we cannot know the future, we can focus on the data to guide our decisions. So, while seasonality and valuations favored a correction in March, the same factors now favor a market bounce in April. Remember, however, that when we are dealing with the future we are dealing with probabilities, not certainties. While anything can happen, April is typically one of the two best market performing months of the year. Does this mean the market is out of the woods for good? No, but a short-term technical bounce is due.

Longer term, the fundamental economic picture carries more weight. We will get more clarity about that as time goes by. Meanwhile, keep in mind there are now $7 trillion parked in money market funds (compared to $6 trillion at the same period last year), which will be looking to get deployed once the FED lowers rates and the money market funds start offering very little yield.

Please reach out with any questions, we are always here to assist you in your investment journey.

Stay Fierce!

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