It’s time to start buying this September pullback in the stock market.

Getting down to brass tacks, here are three reasons why, and five stocks to consider.

Reason #1: Evergrande is not Lehman

Lehman Brothers blew up in 2008 because the U.S. government failed to realize it was too big to fail. Lehman had sold a lot of flawed financial products around the world, so when it blew up, it created systemic problems. That’s not the case with the wobbly Chinese real estate company Evergrande, says Ed Yardeni of Yardeni Research.

Yes, it’s been hurt by stepped-up Chinese government oversight, which seems sensible given its size and huge debt loads.

“But the government’s actions are about creating social and financial stability. They do not want to create chaos,” says Yardeni.

So the Chinese government will intervene to restructure Evergrande, probably by splitting up its businesses among other property developers.

“When, they do, stock markets around the world should enjoy relief rallies,” predicts Yardeni. Bear-market-inducing recessions are typically caused by credit crunches, but Evergrande doesn’t have enough international exposure to cause one on a global scale — unlike Lehman.

“We have been asked repeatedly if a likely Evergrande default is China’s Lehman moment. Not even close,” says Barclay’s strategist Ajay Rajadhyaksha.

His rationale: There are no signs of looming systemic risk in the credit markets. Corporate bond yields are high in China (a sign of potential problems there), but not in the rest of the world. Global banks have not retreated from the interbank funding market or from lending in general.

“The conditions are simply not in place for even a large default to be China’s Lehman moment,” says Rajadhyaksha.

Reason #2: Sentiment has gotten dark

I regularly track sentiment for subscribers at my stock letter Brush Up on Stocks (the link is in the bio at the end of this column). I use sentiment as a contrarian indicator. When most people are bearish, it is time to step up buying. That is the case now. Of course, no one can “call” the exact bottom in a selloff. There could be more to go here. Many accounts are no doubt in margin call now, and the selling related to that can last for days. This may bring more pressure.

But sentiment was already dark enough last week to support more aggressive buying. The Investors Intelligence Bull/ Bear ratio fell to 2.26, for example. Generally, anything below two suggests people are spooked enough to warrant taking the other side of the trade and buying. This ratio is probably below two now, after Monday’s selling. (We will find out on Wednesday, when fresh data come out.)

What’s more, the Chicago Board Options Exchange’s CBOE Volatility Index
VIX,
-5.25%
,
another good sentiment read, spiked sharply on Monday to over 28, significantly above its recent 15-20 trading range.

Another common worry these days is the meme of the moment — that September can be a terrible month for stocks. This is true. However, so many people are talking about this, it possibly means it won’t happen. The market has a tricky way of fooling most of the people most of the time.

What’s more, the September weakness may actually have happened in August. Few people mentioned it at the time (or care to now) but the small-cap Russell 2000
RUT,
+0.18%

was in correction mode in August, falling more than 10%. It’s possible the “September” weakness already happened, in August.

Reason #3: Insiders have turned more bullish

When investors are bearish and insiders are bullish, that is a good time to step up your buying. That’s the case now. Technically, insiders are not outright bullish, according to an insider sell-buy ratio tracked by Vickers Insider Weekly, published by Argus. An eight-week sell-buy ratio they track recently fell to 3.04. That’s above the level of two it must hit for insiders to turn outright bullish. On the other hand, this gauge is down sharply from the much more bearish level of 6.5 in February.

In short, the sentiment among “those in the know,” or corporate insiders, has improved remarkably as the S&P 500
SPX,
-0.08%

and the Dow Jones Industrial Average
DJIA,
-0.15%

marched higher since February. This happened because earnings estimates rose much more than stocks. Insiders see this at their own companies. By their stepped up buying they are telling us that stocks did not rise enough to price in the coming gains in earnings.

Stocks

Below I offer three alternatives: Go with quality, go with energy (a sector that has been especially hard hit but still has good fundamentals); and go with “ground zero,” by investing in quality companies that do a lot of business in China.

Microsoft

In the “go with quality” bucket, I suggest Microsoft
MSFT,
+0.17%
.
Sure, it is not down too much — just 3.7% from recent highs. But you rarely get much of a discount with quality stocks, so you have to take what you can get.

Microsoft just announced an 11% dividend hike and a large $60 billion share-buyback program. These are both statements of confidence — and returns of capital that benefit stockholders. Big picture, Microsoft is killing it in the cloud, with its Azure cloud services. Migration to the cloud is a long-term megatrend that will help Microsoft investors for years. This is part of the digital transformation sweeping every company and every industry, says CEO Satya Nadella.

Recently at $29 billion a year, Azure sales are growing 50% annually, estimates Goldman Sachs analyst Kash Rangan. (Microsoft does not break out the numbers or offer Azure projections.) Overall revenue advanced 21% in the second quarter to $46.2 billion, and net income grew 47% to $16.5 billion. For more on Microsoft, click here.

Energy

Energy names are highly cyclical. Their fates depend on demand for oil and natural gas. So when concerns of a global meltdown crop up, investors flee. But given all the central bank stimulus and government spending in support of the economy, growth will be with us for a while. This will continue to help energy stocks.

ConocoPhillips
COP,
+3.96%

is a dividend investor’s best friend. It pays a nice 2.9% yield. But more importantly, it has pledged a 10-year plan of limited investment, steady growth, and a steady return of cash to shareholders. That “limited investment” part sounds like a negative. But ConocoPhillips will be investing enough to grow production by 3% a year over the next 10 years. In the current selloff, its stock is down 10% from highs earlier this year.

Next, consider the energy-services company Schlumberger
SLB,
-1.17%
,
down 28% from highs earlier this year. Because it is so good at what it does, Schlumberger is the go-to, blue-chip services company for energy producers. Their spending on production will continue to increase as economic growth and energy prices remain strong, one of the reasons Morningstar analyst Preston Caldwell has a five-star rating in Schlumberger.

Ground-zero names

So often in investing, it pays to be the contrarian and run toward problems, not away. If you think you have the stomach for this style of investing, then consider two quality companies that derive a lot of their revenue in China.

First, consider Tencent
TCEHY,
+2.51%
,
the Chinese gaming, social media and cloud services company. Its stock is down 42% from highs earlier this year. Tencent has problems beyond the systemic risk in China posed by Evergrande. The government has stepped up regulation of fintech and gaming, two areas of strength for Tencent.

But Tencent still has a user base of 1.3 billion people to monetize. It’s figuring out new ways to monetize video, for example. It is moving into the overseas mobile game market. It has more fintech products to launch. And Tencent benefits from companies continuing to move to cloud services.

“Our 10-year revenue and adjusted operating profit growth remain unchanged, and we continue to be bullish in the long term,” says Morningstar analyst Chelsey Tam, who puts a five-star rating on the name.

Also consider Yum China
YUMC,
+1.10%
.
Its KFC, Pizza Hut and Taco Bell fast food concepts are popular in China. Yum stock is down 23% from highs earlier this year. Besides Evergrande-related worries about China’s economy, the Covid-19 resurgence there has hurt Yum. But the virus won’t be with us forever. Meanwhile, Yum can do enough business via online ordering and drive-through to offset that. Yum has brand power, and it is a play on the mega trend of the expanding middle class in China — a trend that will continue even if the Chinese government has to restructure Evergrande.

Michael Brush is a columnist for MarketWatch. At the time of publication, he had no positions in any stocks mentioned in this column. Brush has suggested MSFT, COP, SLB and YUMC in his stock newsletter, Brush Up on Stocks. Follow him on Twitter @mbrushstocks.

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