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The era of dip-buying is at an end

Analysis

The end of supportive monetary policy is bringing wild market volatility with it, and the old impulse to “buy the dip” will no longer be rewarded.

More than 20 years of falling interest rates has had a Pavlovian effect on investors, conditioning them to buy the dip whenever markets experience so much as a hiccup. But central bank efforts to rein in inflation by crushing growth are now causing “fierce market gyrations” – and buying the dip is now way to deal with them, according to the BlackRock Investment Institute (BII) (headed up by Jean Boivin, photo at top).

“In this structurally more volatile environment, investors will demand higher risk premia, or compensation for holding both stocks and bonds. What do we think this means? Both tactical and strategic allocations have to adapt more quickly,” BII wrote.

“Portfolios have to get more granular at the sector level. Traditional 60/40 stock-bond portfolios and models won’t work as well anymore. And “buying the dip” is unlikely to be as effective as it was before. The inertia behind those kind of behavioural biases must be overcome, we believe.

BII has cut most developed market equities to a tactical underweight, and is leaning into credit. Japanese equities – where the central bank is still loose and easy with monetary policy – are the exception. In strategic portfolios, stocks are still preferred over bonds, because policymakers will ultimately be happy to live with some inflation. And the reason they’ll be happy to live with some inflation is that they’re responding to political pressures to rein it in.

“In other words, the politics of inflation rule. This implies downside risks to growth and company earnings. Eventually, the damage to growth and jobs from fighting inflation will become obvious , in our view, and central banks will live with higher inflation,” BII wrote.

“Production constraints rooted in the pandemic and exacerbated by the war in Ukraine have led to 40-year highs in inflation. The spike in commodities is a prime example of how these factors have collided into an inflation explosion. And we see an era of structurally higher commodities prices ahead.

The bad news extends into private markets too, where valuations are not immune to the “gyrations” the liquid public markets are experiencing. Still, BII believes allocations should be higher than they currently are in institutional portfolios, though “selectivity is more important than ever.”

“The ability to pick top-performing managers will be more important than ever, in our view, and only some investors will be equipped to do so. We believe central banks are unlikely to provide a backstop to risk assets as they did in the past.”




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