After a weak July jobs report released Friday morning, in which unemployment unexpectedly spiked to 4.3%, Wall Street worries that the U.S. economy may plunge into a recession.
On the face of it, those fears seem legit:
The S&P 500 dropped 1.84%. The Nasdaq Composite lost 2.43%, knocking the tech-heavy index down more than 10% away from its recent all-time high. The Dow Jones Industrial Average fell by 1.51%.
Investors are worried.
But such worries are overblown.
On the contrary, the stock market’s big selloff opens the door for some even bigger buying opportunities.
To understand why, we need to first take a step back and think about how the markets have evolved over the past two years…
Soft Landing Hopes Fade as Economic Data Weakens
The rally on Wall Street throughout 2023 and 2024 has been driven in large part by hopes for a “soft landing” for the U.S. economy.
In such a soft landing, the economy gradually weakens enough to bring down inflation (thereby allowing the Fed to cut interest rates), but not enough to plunge the economy into a recession. The Fed subsequently cuts rates and reinvigorates a slightly weakened economy back to “normal” health.
That’s a soft landing.
Throughout 2023 and the first half of 2024, it looked like we were going to get that soft landing because the economic data was weakening at a so-called “Goldilocks” pace — weakening enough to cool inflation, but not enough to plunge us into a recession.
That pace of weakening, however, has worrisomely accelerated in the past few weeks.
Namely, the July Jobs Report showed that the U.S. economy added just 114,000 jobs last month (one of its lowest paces in the past decade), while the unemployment rate unexpectedly spiked to 4.3% (and the manner in which it is moving higher is consistent with pre-recession behavior).
Suddenly, the markets are worried that the economy is weakening enough right now to potentially plunge us into a recession.
Soft landing hopes are losing traction on Wall Street. Hard landing realities are setting in…
So – are we going into a recession?
We do not believe so.
The Fed’s ’21 Bullets’ Could Propel Stocks 25% Higher
Yes, the economy is weakening substantially right now. The labor market is flashing warning signs, and the unemployment rate is spiking in a manner it tends to only do heading into recessions.
However, the economy is still growing. The Weekly Economic Index, the best real-time measure for U.S. economic growth, is running at normal levels around 2%, so we decidedly aren’t in a recession yet.
Any weakening the economy is suffering through right now can and will be combated by rate cuts from the Fed in the next several months.
They have a lot of ammunition for this battle against a weakening economy.
Remember: They hiked rates 21 times in 2022 and 2023. That means they can cut rates 21 times to help the economy regain momentum.
They have 21 bullets in their chamber, if you will.
The market thinks the Fed will use a lot of those “bullets” in the next few months. It is currently pricing in 6 rate cuts in the next 4 Fed meetings into January 2025, implying two jumbo-sized 50-basis-point cuts and two regular 25-basis-point cuts. We think the Fed will follow that exact path.
All of that rate-cutting should meaningfully restrengthen the economy in a manner which allows it to not just avoid a recession, but enter a strong expansion period, too.
We have to remember that amid all this recession talk, the AI investment boom continues with vigor. Sure, the Big Tech companies like Meta (META), Apple (AAPL), Amazon (AMZN), Alphabet (GOOGL), and others reported mixed quarterly numbers over the past two weeks. But the common theme among all of them generally was: “We’re going to keep spending more and more money on AI… a lot more.“
The AI investment boom remains vigorous. That boom should couple with multiple rate cuts over the next several months to restrengthen the economy and reinvigorate the stock market.
As it relates specifically to the stock market, we believe strong earnings growth and some valuation multiple expansion will work together to help drive stocks higher over the next six months.
Despite weak price action, the Q2 earnings season has been objectively very strong. About 80% of the S&P 500 has reported earnings so far. The average sales growth rate is about 5%. The average profit growth rate is about 11%. Those are excellent marks. We believe the combination of continued strong AI spending trends and rate cuts should drive even higher sales and profit growth rates in the coming quarters. We see profit growth rates accelerating towards 15% in the coming quarters.
Meanwhile, we think rate cuts, lower Treasury yields, and soft-landing hopes will increase investor optimism in a manner which lifts stock valuation multiples up to their Dot Com peak levels of the late 1990s. At that point in time, the S&P 500 was regularly trading north of 25X forward earnings. It is currently trading around 22X forward earnings. That implies at least 10% valuation multiple expansion over the next ~12 months.
Behind 15% profit growth and 10% valuation multiple expansion, we think stocks can rise at least another 25% over the next year or so.
We therefore broadly continue to view the current stock market selloff as a great buying opportunity.
The Final Word
But that great buying opportunity has not arrived just yet…
When it comes to nasty selloffs like what we’re seeing right now, it is often best to buy the dip in tranches at critical technical supports levels and/or when the market is starting to show signs of a potential big rebound.
Per our analysis, the market hasn’t dropped to a major technical support level yet, nor is it showing any signs of wanting to rebound yet.
But we suspect it will and rather soon.
It is best to be ready and prepared for this rebound with a list of great stocks to buy on the dip.
Click here to check out a few stocks on our radar right now.
On the date of publication, Luke Lango did not have (either directly or indirectly) any positions in the securities mentioned in this article.
P.S. You can stay up to speed with Luke’s latest market analysis by reading our Daily Notes! Check out the latest issue on your Innovation Investor or Early Stage Investor subscriber site.
