By Michael Brush
It’s time to start buying this September pullback in the stock market.
Getting down to brass tacks, here are three reasons why, and five stocks to consider.
Reason #1: Evergrande is not Lehman
Lehman Brothers blew up in 2008 because the U.S. government failed to realize it was too big to fail. Lehman had sold a lot of flawed financial products around the world, so when it blew up, it created systemic problems. That’s not the case with the wobbly Chinese real estate company Evergrande, says Ed Yardeni of Yardeni Research.
Yes, it’s been hurt by stepped-up Chinese government oversight, which seems sensible given its size and huge debt loads.
“But the government’s actions are about creating social and financial stability. They do not want to create chaos,” says Yardeni.
So the Chinese government will intervene to restructure Evergrande, probably by splitting up its businesses among other property developers.
“When, they do, stock markets around the world should enjoy relief rallies,” predicts Yardeni. Bear-market-inducing recessions are typically caused by credit crunches, but Evergrande doesn’t have enough international exposure to cause one on a global scale — unlike Lehman.
“We have been asked repeatedly if a likely Evergrande default is China’s Lehman moment. Not even close,” says Barclay’s strategist Ajay Rajadhyaksha.
His rationale: There are no signs of looming systemic risk in the credit markets. Corporate bond yields are high in China (a sign of potential problems there), but not in the rest of the world. Global banks have not retreated from the interbank funding market or from lending in general.
“The conditions are simply not in place for even a large default to be China’s Lehman moment,” says Rajadhyaksha.
Reason #2: Sentiment has gotten dark
I regularly track sentiment for subscribers at my stock letter Brush Up on Stocks (the link is in the bio at the end of this column). I use sentiment as a contrarian indicator. When most people are bearish, it is time to step up buying. That is the case now. Of course, no one can “call” the exact bottom in a selloff. There could be more to go here. Many accounts are no doubt in margin call now, and the selling related to that can last for days. This may bring more pressure.
But sentiment was already dark enough last week to support more aggressive buying. The Investors Intelligence Bull/ Bear ratio fell to 2.26, for example. Generally, anything below two suggests people are spooked enough to warrant taking the other side of the trade and buying. This ratio is probably below two now, after Monday’s selling. (We will find out on Wednesday, when fresh data come out.)
What’s more, the Chicago Board Options Exchange’s CBOE Volatility Index /zigman2/quotes/210598281/delayed VIX +54.04% , another good sentiment read, spiked sharply on Monday to over 28, significantly above its recent 15-20 trading range.
Another common worry these days is the meme of the moment — that September can be a terrible month for stocks. This is true. However, so many people are talking about this, it possibly means it won’t happen. The market has a tricky way of fooling most of the people most of the time.
What’s more, the September weakness may actually have happened in August. Few people mentioned it at the time (or care to now) but the small-cap Russell 2000 /zigman2/quotes/210598147/delayed RUT -3.67% was in correction mode in August, falling more than 10%. It’s possible the “September” weakness already happened, in August.