Wall St Week Ahead Stay sidelined or scoop up stocks? Investors weigh choice as market slides

NEW YORK, Oct 7 (Reuters) – As a painful fall in markets drags on, investors face a tough choice: stick with stocks and hope for a turnaround, or avoid one until better times come.

The S&P 500 is down 23% year-on-year, with a brief October rally threatening to crumble after strong US jobs data underpinned the case for more market-punishing rate hikes from a Federal Reserve that has made fighting inflation its top priority.

As markets plummeted this year, cautious investors have trimmed their stock holdings in favor of safer territory, lured by higher yields on everything from government bonds to money market accounts.

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However, some investors are beginning to worry that sitting on the sidelines once the market turns could ultimately cost them. Missing out on a few big days of gains can eat away at total returns over time, while previous market bottoms have been marked by furious rallies that have rewarded those who have stuck it out in stocks.

“It’s a back and forth. Am I more afraid of being underinvested and missing out on an upside and a rally, or more afraid of making a wrong decision,” said Glenn Koh, head of global equities trading at Bank of America.

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History shows that underinvesting in stocks can result in missing out on significant gains. According to a study by the Wells Fargo Investment Institute, investors’ average annual returns fell from 7.8% per year to 3.2% if they missed the 20 best trading days of the past three decades.

Meanwhile, according to Goldman Sachs research, the market tends to post its strongest gains in the month after bottoming out. The company found that the S&P 500 (.SPX) has returned a median of 16% in the month following the bottom of eight bear or near bear markets since 1980.

John Lynch, Comerica Wealth Management’s chief investment officer, believes that a lot of the bad news is already priced into the markets, including fears of a recession. His firm maintains its default allocation to stocks in general in its portfolios.

“The upside in 12 to 18 months is way better than the downside … in three to six months,” Lynch said.

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Investors will be looking to next week’s US CPI report for clues as to whether the Fed’s already implemented 300 basis point rate hikes have dampened inflation. Signs that prices remain elevated should weigh on markets and further undermine the case for staying in equities.

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Many investors believe it’s too early to go bullish on stocks. Valuations are a concern: The S&P 500’s forward price-to-earnings ratio has fallen to about 16 from nearly 22 at the start of the year, but remains above levels of about 10 times the earnings recorded during the 2007-2009 financial crisis Crisis.

And while earnings estimates have softened, they could fall further in the coming weeks as investors discount a potential economic slowdown. The challenges to the company’s outlook will become clearer starting next week when the third quarter results are released.

Morgan Stanley strategists said this week the stock market is poised for further downside, pointing to earnings uncertainties including a stronger dollar and weakness in Europe.

“This is one of the most difficult macro forecasting environments most companies have ever encountered,” they wrote.

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Conventional equity funds have seen 35 weeks of net outflows amid the uncertainty, according to Refinitiv Lipper. Meanwhile, fund managers increased their average cash balances to the highest level in more than two decades, according to BofA Global Research’s latest monthly survey.

King Lip, chief strategist at Baker Avenue Asset Management, said many of his investment clients are more concerned about larger potential losses than missing out on some potential gains.

In fact, some of the company’s clients are looking to continue increasing their cash positions — though many now hold 5% to 10% of their portfolios in cash, compared to their more typical low-single-digit allocation.

“Right now it’s not about missing the recovery per se, it’s about capturing another 20-30% of the downside,” Lip said. “That’s what our customers are worried about right now.”

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Reporting by Lewis Krauskopf in New York Editing by Ira Iosebashvili and Matthew Lewis

Our standards: The Thomson Reuters Trust Principles.

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