I think that a lot of investors are wondering whether the dip in markets this week will lead to a full stock market crash. It’s too early to say for certain, but the stabilisation seen as we close the week gives me confidence. I think that the reasons in favor of buying the dip carry more weight than the concerns about a larger crash. Let me explain.
Adjusting for inflation
First, I want to discuss one of the fundamental reasons for the slide in the FTSE 100 this week. On Tuesday and Thursday, large drops were seen as investors became concerned about rising inflation expectations.
For example, in the US, data showed that inflation for April moved up to 4.2%, from 2.6% in the previous month. Given the international exposure of companies in the FTSE 100 index, this weighed on UK stocks as well as US ones.
The concern is that higher inflation leads to higher interest rates. These then lead to higher costs of issuing debt. The vast majority of FTSE 100 companies have debt, so this would be a negative impact.
The reason why I don’t think this will lead to a full stock market crash is that investors have time to price this in. Inflation expectations can rise, but it’s a known event to prepare for. This is in contrast to the crash last year, which was driven by the unexpected pandemic. This took the market by surprise.
I’d hope that companies manage debt levels appropriately. Therefore, higher rates in a year or so shouldn’t be a large enough catalyst to see a significant drop. The risk to my view is if inflation in coming months accelerates out of control, but I struggle to see this.
A healthy dip, not a stock market crash
Another reason why I’d buy the dip in the FTSE 100 this week is from looking at recent price movements.
For example, let’s rewind to the start of the year. After posting impressive gains, the index fell to circa 6,350 points at the end of January. This turned out to be a temporary dip, and by the middle of February, we were back above 6,700 points.
We saw another dip at the end of February, but shares bounced higher in March. The point I’m trying to make here is that it’s normal to have dips of 1%-5% as part of a longer-term uptrend in the market.
Prices don’t move in a straight line. So I see this slump as just another healthy dip that allows the market to correct before (hopefully) moving higher again. I’ve previously covered some specific companies that I’m thinking about buying, such as Flutter Entertainment and Rightmove.
The risk to this point is that past performance doesn’t predict future returns. That’s a phrase used a lot, but it’s used for a reason! Just because the market hasn’t crashed from previous dips in the past few months, doesn’t mean this time has to be the same. So I do need to be careful about making assumptions about the future.