6-Part Investing Strategy for a Stock Market Pullback: Lundgren

All three of the top US stock indexes reached record highs in mid-May following a sharp but brief sell-off in April. However, Lundgren noted that modest market breadth suggests there’s room for stocks besides the large-cap growth leaders to rise.

“The average stock is still, arguably, not participating,” Lundgren said. “So we still have a very bifurcated environment where large caps are very much favored — in particular, mega caps. But those are all nuances beneath the surface that can distract us from the bigger picture, which is that this is a bull market.”

Stay patient, and pounce when there’s a pullback

Although Lundgren is a firm believer in the long-term bull market, he cautioned against chasing this rally. Instead, he’d recommend waiting for a drawdown before buying.

“This is not a good time to be loading the boat and getting super bullish right here,” Lundgren said. “I’d rather get bullish when the market’s oversold.”

Lundgren makes market calls and investment decisions based on the market’s momentum instead of trying to outsmart his peers. He tries to swim with the tide instead of going against it, though he occasionally has to take a tactical approach if he senses that a reversal is afoot.

“The way I think about it is that the market’s the best macro strategist on the planet, and it has a very good record of being able to identify good versus bad conditions prospectively,” Lundgren said.

While investors may have moved past the S&P 500’s 5.5% pullback in early April, Lundgren thinks they should stay wary and watch for a similar drop in the coming weeks or months. He didn’t say when a rally-snapping drawdown would arrive — only that history says it’s inevitable.

“We did do a lot of damage to the shorter-term trends, which means that the next rally that we get is likely to be just part of what I think is — the market’s likely gone into a corrective period,” Lundgren said.

There can be negative or positive stretches within an established bull or bear market, Lundgren noted. He keeps an eye on weekly and quarterly charts to track these discrepancies, and what he sees now doesn’t make him optimistic.

“We have a setup that’s similar to what happened in the fall of last year, where we have this sort of churn, sideways price action for the next several months,” Lundgren said, adding that the market choppiness can persist into the US election season.

But despite his trend-following tendencies, Lundgren also has a contrarian side. The strategy chief advises adding to stock positions when the next downturn arrives.

“If we get a 5% pullback, you should be using that as an opportunity — as painful as it is — because the behavioral bias is now that we’ve rallied, now you want to buy it,” Lundgren said. “The way we should be thinking about it is, when you get the 5% pullback, that’s the worst time to be selling, and that’s the best time to be buying — not after we’ve already had a 5% rally.”

Follow this 6-part investing blueprint in a pullback

Last fall, Lundgren highlighted five economically sensitive sectors he expected to outperform.

Those five cyclical groups are still his favorite parts of the market, he said, as are financials, consumer discretionary, energy, industrials, materials, and technology. His research indicates that those sectors have the strongest technical momentum.

Since the start of September, which is right after Lundgren greenlighted those latter five groups, four popular exchange-traded funds (ETFs) built to track those sectors have trailed the S&P 500. Only the Technology Select Sector SPDR Fund (XLK) has outperformed the index.

However, Lundgren is focused on the performance of sectors on an equal-weight basis, while those ETFs give more sway to larger companies. When adjusting for market cap, cyclicals have fared much better and have bested the equal-weight version of the S&P 500 in several cases.

Even though the longtime strategist is concerned about the market’s near-term trajectory, he’s sticking with economically sensitive stocks — not the defensives that tend to fare best during drawdowns. Lundgren is confident risks are already priced in, and if not, he’ll adjust accordingly.

“We might have a lot of apprehension about what we see on the horizon, but there’s nothing that we see that the market doesn’t see,” Lundgren said. “And there’s a whole bunch of stuff that the market sees that we don’t see.”