Market malady: 3 reasons why the world's largest money manager is not buying the dip

Stock market News

If you are scared of the volatility in the market and sitting on the fence, you are not the only one. Even the world's largest institutional investor with $10 trillion in assets - Blackrock -is not buying the dip.

Their decision seems to be contrarian to many institutional investors, including those in India, who have advocated 'buy the dip' as the equities have fallen in recent months, thanks to rising market headwinds.

"US stocks have suffered the biggest year-to-date losses since at least the 1960s. That’s ignited calls to 'buy the dip'. We pass, for now," said Wei Li, Global Chief Investment Strategist at BlackRock Investment Institute. "We’re not buying the stock dip because valuations haven’t really improved, there’s a risk of Fed overtightening, and profit margin pressures are mounting."

She and her team members explained three reasons why they are sitting on the fence:

1. Margins to crumble

The two-decade upward march of profit margins is likely to stop now and risks are emerging towards the downside. Blackrock expects the energy crunch to hit growth and higher labour costs to eat into profits. The problem is, according to Blackrock, analysts have not been able to incorporate this in their estimates. "Analysts expect S&P 500 companies to increase profits by 10.5 percent this year, Refinitiv data show. That’s way too optimistic, in our view," the investor said.

2. Valuations still high

Blackrock believes despite about 20 percent drop in the overall market, equities haven’t cheapened that much. "Valuations haven’t really improved after accounting for a lower earnings outlook and a faster expected pace of rate rises. The prospect of even higher rates is increasing the expected discount rate. Higher discount rates make future cash flows less attractive," Li said in a note.

3. Fed risk

The money manager is also wary of the possibility that the US Fed may tighten the money supply bit too much in order to tame the record inflation. Signs of persistent inflation, like last week’s CPI report, may fuel the risk. Li said she doesn’t see a sustained rally until the Fed explicitly acknowledges the high costs to growth and jobs if it raises rates too high. "That would be a signal to us to turn positive on equities again tactically."

Blackrock said it is overweight on equities from a strategic point of view but has trimmed overall tilt as the relative appeal versus bonds has diminished. It also sees more value in the developed market compared to other geographies.

"Incorporating climate change in our expected returns brightens the appeal of developed market (DM) equities given the large weights of sectors such as tech and healthcare in benchmark indices. Tactically, we are neutral DM equities due to a higher risk of central banks overtightening policy and a deteriorating growth backdrop in China and Europe," said Blackrock.

Strategic means long-term and tactical means 6-12 months.

Though these risks are largely US-centric, some of those hold true for other markets as well, including India. Compared to its peers, Indian equities are still expensive as Motilal Oswal pointed out earlier this month that in P/E terms, MSCI India is trading at an 87 percent premium to MSCI Emerging Markets (EM), above its historical average of 61 per cent.

Inflation in India is still rising with more room to grow, which may induce string moves by the Reserve Bank. Margins for corporates have already seen a slump in the fourth-quarter earnings and now some analysts believe a downgrade in earnings estimates is likely.

Not surprisingly, Blackrock said it is neutral on EM equities given challenged restart dynamics, high inflation pressures, and tight policies.