Smart Money Buying the Dip Offers Glimmer of Hope That Bottom Is In

(Bloomberg) — Behind the scenes of Monday’s trillion-dollar selloff, big-money investors were doing something usually reserved for the retail crowd: buying the dip.
While newbie investors bailed, hedge funds that make both bullish and bearish equity wagers snapped up individual US stocks at the fastest pace since March, reversing a months-long selling spree, data compiled by Goldman Sachs Group Inc.’s prime brokerage show. Separate JPMorgan Chase & Co. analysis showed institutional investors scooped up $14 billion of shares on net during the downdraft, which lopped 3% off the S&P 500 Index.
That professional traders picked the worst day of the year to dive back in bolsters a host of bullish arguments, among them that all the volatility is an overreaction to economic data that, while weakening, has yet to confirm a recession. And shares’ sharp rebound from the lows suggests hedge funds were on to something. But it’ll take more than just another turnaround-Tuesday to prove the pros beat the day-trader set to the bottom of a market where valuations remain elevated by almost any measure.
“It’s like seeing a designer bag you’ve wanted marked down 10%,” said Max Gokhman, senior vice president at Franklin Templeton Investment Solutions. “It’s still very expensive, but you can tell yourself it’s a deal.”
The S&P 500 Index advanced about 1% on Tuesday, following the worst session in almost two years the day before. The Nasdaq 100 Index gained a similar amount. Wall Street’s chief fear gauge — the Cboe VIX Index — fell from the highest since 2020, as did the VVIX Index, which measures the volatility of the VIX.
The depth of the recent rout, if taken from the close of trading immediately preceding last week’s Federal Reserve decision, is far less dire after Tuesday rebound. The five-day decline sits at 3.6%, in line with similar drawdowns over the last five years. 
Whether Monday’s gyrations in stocks mark the bottom is anyone’s guess, and the list of concerns for investors remains long. Earnings results from Big-Tech giants raised concern that spending on artificial intelligence has gotten too high relative to near-term returns. And last week’s monthly jobs report added to concern that the Fed is waiting too long to reduce interest rates.
Rotation Signal
Professional investors’ rotation back into US stocks on Monday comes after hedge funds spent the last few months shifting out of individual shares, with July seeing the largest unwind in notional value since 2016, Goldman Sachs data show. 
While the wall of worry remains, some investors say that the recession angst that helped push the Nasdaq 100 Index into a correction and the S&P 500 down 7% from its peak is premature. Earnings season has shown that companies in the S&P 500 grew their profits by 12% in the second quarter, with more than 80% of the reported earnings scorecards exceeding estimates, according to Bloomberg Intelligence data.
“Many hedge funds see a selloff as a buying opportunity,” said Jonathan Caplis, chief executive officer at PivotalPath, a hedge fund research firm. “The majority of the managers we speak to are framing the current problems as short-term and sentiment-driven, versus a long-term issue with the fundamentals of listed businesses or even the wider US economy.” 
And if history is any guide, the recent pullback does spell opportunity. Since 1980, the S&P 500 Index has generated a median return of 6% in the three months that followed a 5% decline from a recent high, according to the Goldman strategy team led by David Kostin.
Kostin’s group stops short of giving a recommendation from the findings. But the team cautions that the outlook for the benchmark index following a slump of 10% has been “markedly different” when it has taken place in an environment of resilient economic growth than when it has happened as part of a correction ahead of a recession.
They note that US equities are still not pricing in an economic contraction, even though growth-sensitive cyclical stocks have trailed defensive shares in this month’s rout. 
Meanwhile, the strategy team at Citigroup Inc. warned this week that “recessionary scenarios are by no means priced in.”
The bank’s so-called bear-market checklist — which measures metrics such as stock valuations, the yield curve, investor sentiment and profitability — recommends “buying into weakness,” Citi strategist Beata Manthey wrote in a note. But “we would feel more comfortable doing so once we see evidence of a more complete positioning unwind,” she said.
–With assistance from Sagarika Jaisinghani.
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