Why This May Be the Best Week of the Year to Pile into Stocks

What a week it has been…

During the course of the past five sessions, the S&P 500 has corrected by 10%. Yesterday, it suffered its worst day of trading since 2011. And the Shanghai stock market tumbled 19% during the past week, erasing all of its 2015 gains.

As someone who manages money for private clients, it is a challenging time. Unlike when I was a mutual fund manager and my job was to be “fully invested” through thick and thin, I am forced to make decisions on whether to ride out these sharp corrections — or to put a big chunk of my clients’ assets in cash.

On the one hand, my clients are understandably worried.

On the other, it is astonishing how little objective data there is to support the notion that we are on the verge of another 2008-style economic meltdown.

So, I am going to go out on a limb here:

I think the current sell-off is massively overdone.

And I think that when you look back in three months as we enter a traditional Q4 rally, this week will be the buying opportunity of the year.

The China Sell-off in Perspective

Yes, the Chinese stock market bubble has popped, wiping out trillions of dollars of paper wealth, mostly for the Chinese retail investor. And the knock-on effect of the change in sentiment on developed markets across the globe has been even greater.

But the Chinese stock market — let alone those in the United States, Europe and Japan — does not disappear because of a crash. Ironically, the Chinese blue chips are among the cheapest in the world with iShares China Large-Cap (FXI) trading with a price-to-earnings (P/E) ratio now in the single digits. It is now trading where it did in March of 2014 — before the big rally in Chinese stocks began.

The sell-off in China does, however, show the vulnerability of emerging markets in general, following years of talk of the BRICs (Brazil, Russia, India and China) taking over the world.

Back in 2011, Russia’s Vladimir Putin commented that the United States “is living like a parasite off the global economy.” That’s ironic coming from a country whose fate is so strongly linked to the price of oil.

But parasite or not, your pension fund is unlikely to be moving your retirement assets to Moscow or Shanghai anytime soon.

The Bullish Case — The Fundamentals 

You don’t need me to tell you about the bearish case for global financial markets. You can find that anywhere.

But here are two reasons to be bullish, which you won’t find in a media that reports 13 negative stories for every positive one.

First, U.S. stocks aren’t cheap. But they aren’t off the charts expensive either. That’s hardly a euphoric level that signals the onset of a crash. Recall the words of Sir John Templeton, “Bull markets are born in pessimism, grow on skepticism, mature on optimism and die on euphoria.”

If anything, we’re at the “pessimism” phase of this cycle and not at “euphoria.”

Second, falling oil prices are their own “stimulus package” to U.S. consumers. Deutsche Bank estimates that when gas falls to $3 a gallon, the reduced pricing frees up $100 billion in annualized consumer spending. With gas now at an average of $2.57 in the United States, all this adds up to more money in U.S. consumers’ pockets. That should be bullish for U.S. stocks as well, except for the hard hit energy sector.

The Bullish Case — Investor Sentiment

I’m a big believer in the distortions caused by market psychology.

Nobel-Prize-winning theories about “rational expectations” to the contrary, investors are anything but homo economicus — the perfectly rational actors.

Financial markets are much more like Mr. Market, the metaphorical manic-depressive, who was first described by Ben Graham and popularized by his student Warren Buffett.

Some days, Mr. Market is euphoric. On other days, he’s very depressed. If you catch him on a euphoric day, he wants a very high price for his shares. If he’s in one of his down moods, he’s willing to sell you his shares for a pittance. Mr. Market highlights the one thing you can predict with certainty about financial markets: investors will always overreact to events — whether positive or negative.

There are some terrific ways to quantify these mood swings. You can look at everything from age-old stalwarts like the AAII investor sentiment survey to my favorite compilation of market sentiment, the CNN Fear and Greed Index.

Sentimentrader.com also does some terrific work to quantify the normally unquantifiable. It points out that the recent market action is chock full of once-every-few-years moves with all sorts of extremes. Specifically, when markets open sharply lower like they did yesterday, without exception, U.S. stocks were trading higher two weeks later. And with only two exceptions, they were also trading higher in the next one or three months.

That doesn’t, of course, mean that stocks can’t continue to fall this week…

But look for stocks to bottom sometime this week. And strap yourself in for a wild ride.

In case you missed it, I encourage you to read my e-letter column from last week about how to profit from the cable-cutting mega trend. I also invite you to comment in the space provided below my commentary.