Investors Keep Faith in Bull Market as Early Dip Gives Buy Sign

Jul 11, 2014 1:22 am ET

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July 11 (Bloomberg) -- When the U.S. stock market opened yesterday, the Standard & Poor’s 500 Index was poised for the first 1 percent drop in three months. Then the bulls stepped in.

The U.S. equity benchmark pared most of its losses during the day, closing down 0.4 percent amid speculation the initial selloff was overdone. Any slump in the market will be temporary and represents a good time to buy, said Craig Hodges, manager of the $1.4 billion Hodges Small Cap Fund that’s beaten 99 percent of its peers over three years.

“We have a list of 15 to 20 names that we’d like to buy at a cheaper price, and so we kind of like days like today, where some of the weak holders get shaken out of stocks,” he said in a phone interview yesterday from Dallas. “There is still a lot of money on the sideline that’s looking to be put to work.”

The S&P 500 fell as much as 1 percent in the first half hour of trading, tracking a plunge in European equities and Portuguese bonds. Missed debt payments by a company linked to the Iberian nation’s second-largest lender fueled concern that the euro region remains vulnerable to shocks as it emerges from a sovereign debt crisis.

The U.S. benchmark erased more than half its decline by 11 a.m. in New York.

Investors were looking for an excuse to trim equity positions and got it in the form of the delayed Portuguese bond payments, Aurion Capital Management’s Greg Taylor said. That presented an opportunity for his firm to buy.

Buy Tickets

“This is the self-fulfilling condition we’ve all been waiting for,” Taylor, a fund manager at Aurion Capital in Toronto, which manages about C$6.6 billion ($6.2 billion), said in a phone interview. “We’re getting our buy tickets ready.”

Hodges said his firm holds about 10 percent in cash, and on its watch list are airlines such as United Continental Holdings Inc. The Chicago-based carrier soared 13 percent yesterday after losing as much 20 percent in the previous month.

Yesterday’s decline came after speculation that U.S. stocks have risen too far, too fast fueled losses earlier in the week. Raymond James & Associates Inc. warned that equities are vulnerable, while Citigroup Inc.’s chief U.S. equity strategist cited concerns for a “severe” pullback.

The S&P 500 has not had a drop of 10 percent in more than two years, and has not fallen by more than 1 percent on a closing basis since April. The gauge trades at a valuation of 18 times reported earnings, the highest since 2010.

Dow 17,000

The S&P 500 ended last week at an all-time high and the Dow Jones Industrial Average topped 17,000 for the first time. Concern the bull market is overextended has led some investors to purchase protection to guard against more pronounced declines.

Traders own 2.1 bearish options on the S&P 500 for every bullish one, around the most since 2008. About 3.7 VIX options betting on upside in the volatility gauge are owned for every one wagering on it going lower, the highest call-to-put ratio for the contracts since before the financial crisis.

Three days of equity losses this week have come with a surge in volatility after months of calm in stock markets. The Chicago Board Options Exchange Volatility Index jumped 8.1 percent to 12.59 yesterday. Europe’s VStoxx Index surged 10 percent to 16.66, headed for the biggest weekly increase in nearly six months.

Trimming Equities

Not everyone treated the market pullback as a buying opportunity. Leuthold Group LLC said it’s trimming equities in some funds on concern the S&P 500 may slump as much as 8 percent in the coming months.

The Minneapolis-based firm is cutting stock holdings in tactical funds to 60 percent from about 65 percent, Chief Investment Officer Douglas Ramsey said in a phone interview with Bloomberg News. The drop will eventually turn into a buying opportunity as equities resume their advance later in the year, he said.

If stocks were at loftier valuations, Leuthold would consider trimming holdings in the tactical funds to about 30 percent, which it did in 2007 prior to the financial crisis, according to Ramsey. The firm can adjust the equity allocation to between 30 and 70 percent, he said.

Shallow Correction

“In the grand scheme of things, this will be a pretty small move,” Ramsey said yesterday in a phone interview. Leuthold oversees $1.7 billion. “We’re going to see a shallow 6 to 8 percent correction this summer.”

While the stock market may extend today’s declines, in the long term, equities are supported by an expanding economy and improving labor market, according to Mark Luschini, chief investment strategist at Janney Montgomery Scott LLC.

U.S. gross domestic product will probably expand 3.1 percent from July through December following a 3.3 percent advance last quarter, according to the median forecast economists polled from July 3 through July 9. It would be the first time since 2004-2005 that GDP has sustained such gains over an extended period.

“There’s still too much sideline cash,” Luschini said by phone. Philadelphia-based Janney Montgomery Scott oversees $65 billion. “Too many under-invested institutional investors that would quickly come into the market and serve to put a floor in before this got ridiculous.”

--With assistance from Eric Lam in Toronto.