Since early September, the stock market has encountered some selling pressure. From peak to trough, the S&P 500
It was the biggest drop in stock prices since the March bottom. Naturally, this raises the next question of whether this is going to be a short-lived dip or the start of an extended correction?
Someone who believes that this is likely a dip that will lead to a V-shaped rebound would cite that it's likely that stocks began in a new bull market in late March. In the early stages of these bull markets, the dips are furiously bought as people who are underinvested want to add exposure.
Further, it's been interesting that while the indices are down, many stock market components are flat or up. This adds credence that this is more of a rotation rather than distribution.
The dip has done its job in punishing overbullish and overleveraged traders. Now, the next batch of leading stocks is setting up to break out higher.
Assuming that we are in a new bull market. a correction is another way in which the market can reset. These last anywhere from 3 to 8 weeks and typically have multiple rally attempts that fail. It can turn sentiment from bullish to bearish. By the end, many people are convinced that a new bear market is imminent.
Some pieces of evidence to support this argument are that sentiment hit historical levels of bullishness in terms of call buying and overbought, technical readings. Further, the economy may weaken given the damage incurred earlier this year and failure to reach a new, stimulus deal. It would make sense that a more meaningful, pullback is necessary for the market to reach equilibrium.
Both sides have compelling cases, but the weight of the evidence supports the V-shaped dip camp. Many sectors connected to economic growth like manufacturing are showing signs of breaking out despite the bearish price action.
Additionally, we have learned from previous years that when the Federal Reserve is maximally engaged and committed to supporting the economy that "buy the dip" tends to work.
Finally, we have the powerful dynamic of underinvested fund managers underperforming the market. This circumstance tends to also lead to shallow dips rather than extended corrections.