Understand The Environment Before Buying The Dip In The Market Or The Mag 7

Main Thesis & Background

The purpose of this article is to evaluate the broader equity market, with a specific focus on the Tech sell-off that has occurred over the last few weeks. The topics discussed here will be how this has disproportionately impacted the “Mag 7”, why it may not be a buying opportunity, and how investors can remain disciplined in the months ahead.

I see this as an important exercise because, despite the NASDAQ 100 (which is overweight the Mag 7) hitting correction territory recently, it is by no means “cheap” to buy this index. The Mag 7 – and other large-cap Tech stocks – had been on a strong run for the past year and a half that leaves the indices that track them sitting at historically high levels despite the pullback. In fact, the S&P 500 (which is Mag 7 heavy) is still almost 20% higher than where it sat before the Fed began hiking interest rates in 2022:

The point of reference here suggests that stocks (as measured by the S&P 500) could have further room to fall. If we rewind the clock just a few months, current levels would seem expensive – even if they are off the recent highs.

For this reason, I am going to dig into how sustainable current valuations are and whether buying the dip here is actually the prudent thing. I see some macro-headwinds on the horizon that suggest patience may be the virtue to consider going forward.

Euphoria Is Dangerous

Let’s examine how we got here: The US equity market – especially the large-cap corner – had been on fire in 2024 for the most part. This was due to resilient economic growth in the US, investors with hopes of interest rate cuts, and foreign assets flowing into domestic markets. All of this left us with more investors chasing the same number of stocks, which meant valuations have become stretched even as corporate earnings have risen.

This is important because it underscores why one may want to be patient at this moment. Yes, stocks have taken a beating lately and may appear cheap in relative terms. But that is a very short-term view. If we look back further, we see that equity markets have been climbing for a while and investors have been “paying up” to own these names. The reality is that the Mag 7 has been a winning theme, and many investors have been playing catch-up to amplify their exposure to these names. We see this because multiple expansion was a significant source for total returns in the second quarter:

What this is showing is that the Mag 7 and the S&P 500 have certainly had their share of earnings growth and dividends. But it also indicates that a large share of the gains investors have enjoyed has been due to the “P” rapidly rising in the P/E equation. Investors have been sending the valuations of these stocks into expensive territory.

The takeaway for me is that I would urge my followers to tread carefully here. Yes, dips and “corrections” are often buying opportunities. That could sure be the case here as well, and I wouldn’t fault anyone for buying into weakness. But we have to be level-headed and remind ourselves where we are in relative terms. Stocks went into this correction at all-time highs and very lofty valuations. That means a swift move back to those prior levels will not be easy, and there is perhaps more pain on the way. Keep this in mind before jumping on the urge to buy on any upcoming down days.

Volatility Is Still Elevated

Another reason to be cautious is that market volatility is still well the calm we had been enjoying for most of the year. While it has backed off the recent high when stocks were swooning, we can see that investor anxiety is still a bit elevated. That tells me that we aren’t “out of the woods” yet, so to speak, in terms of bigger intraday swings in equities:

I think this is an important metric to continuously monitor, and the level it sits at right now is a “wait and see” level for me. What I mean by this is that we aren’t in the calm/complacent market where investors are not worried enough about what could go wrong. On the other hand, the panic we saw recently has subsided, so it isn’t exactly a screaming buy opportunity either.

This isn’t meant to be contradictory. Rather, it is meant as support for my current level of caution. I am all for selling into strength and buying into panic – but I don’t see either of those scenarios at this moment, and I am not going to force my mind to decide. When I don’t see a strong signal, either way, I wait. And that’s primarily what I’ll be doing in the week ahead.

Employment Picture Softening – Mixed Bag

My next macro-topic is the labor market. This has been a source of strength coming out of the worst of the Covid-19 pandemic and until very recently. The tightness is the labor market has helped sustain positive economic growth and contributed to strong consumer spending – a major driver for the US economy.

The challenge going forward is that this backstory is starting to soften. Layoffs are becoming a much more common headline from many major corporations across the country. This has contributed to a rise of both the unemployment and underemployment rates in the US:

There is some good news to be found in this generally perceived negative figure. One is that unemployment is still quite low. At just over 4% we are nowhere near red flag territory. If the labor market improves just slightly in the months ahead, there won’t be much cause for concern.

The second positive is that a softening labor market could force the Fed’s hand to cut rates. Lower interest rates are what the market has been clamoring for, so perhaps if they get it, then the equity volatility will subside a bit.

A third positive is that a weaker employment market means that employers have the upper hand again when it comes to wages. That may not be “good” for workers or consumers, but it can be good for corporate profits and, therefore, investors. In fact, this is already starting to play out on a macro-level, with labor costs falling sharply off their recent highs:

As noted above, this could be a boost for corporate earnings going forward if compensation expenses are kept in check. However, that can have ripple effects downstream if it contributes to a weaker consumer spending environment and/or slower economic growth. Hence, the “mixed” signal this presents – it can be good for corporations in isolation, but bad overall if too many companies cut costs through layoffs and/or lower pay. Time will tell how this plays out, but for now, this attribute supports a more cautious investment stance.

Don’t Overthink The Drop – It Is Normal

My final point is one to hopefully calm some nerves. In this review, I have discussed some macro-concerns I have and why I think a disciplined approach has merit going forward. But I am not flashing a panic or sell signal here. In these environments, even if I am not buying aggressively, I don’t want to be a seller. I sell during times of complacency and strength, and this isn’t one of those times.

But we have to remember, what is going on right now is more normal than one might expect. During bull market runs, it is easy to forget that markets go up and down, and that is not an inherent problem when one has a long-term investment horizon. In fact, even 10% drops – as we have seen in the NASDAQ 100 – are quite common. Looking back at the last 52 calendar years, we have seen drops of 10% or more on 30 occasions:

The simple fact is that equity investing can be volatile. Drops between 10% and 20% are something we need to live with. But it makes sense to either buy during those time periods if you have the cash, or stay calm if you don’t (or if you don’t want to amplify your equity position due to risk tolerance). The worst thing one can do in these time periods is panic sell – I would not advocate for that, and I am certainly not doing so now. But a realistic look at the risks facing us and being prudent with cash is different from selling during a market rout. That is the point of emphasis here.

Bottom Line

The US equity market has seen a wide sell-off and a resurgence of volatility that had been lacking for most of 2024. While this may present an opportunity for some, I would urge some level of caution. US stocks are still sitting near record levels and the Mag 7’s rise – while paramount – was partially driven by premium expansion. This means valuations are elevated even with the recent correction, so buying in now is not exactly value investing.

Importantly, this comes at a time when global markets are fraught with geopolitical risk. With a US election looming, unrest in the Middle East, and a prolonged military conflict in Eastern Europe, one would not be surprised to see the geopolitical risk index has seen a surge higher:

The conclusion I draw here is to remain focused on the long term, but to proceed with caution. Those who are patient at this juncture are likely to be able to see further volatility ahead as a buying opportunity – something that cannot happen if dry powder is used too early. I see the recent correction in markets as a beginning of more volatility ahead, given that valuations and risks are simultaneously high. Therefore, I would caution readers to be very selective on new entry points for the time being.