Chief money managers are using the stock-market carnage to funnel into key sectors. Here's what they're buying.

• Recession fears have dragged down major indexes since Thursday.
• Weak manufacturing and jobs data contribute to market sell-off, raising economic concerns.
• Experts see buying opportunities in US large caps, Japanese stocks, and dividend growers.

Recession fears have dragged the stock market down since Thursday as investors digested a wave of bad economic data. All three major indexes took a hit. Early on Tuesday, the S&P 500 was down by 2.97%, the Dow was down 2.6%, and the tech-heavy Nasdaq was down 3.39% for the week.

The market's optimism seems to have been caught off guard as key readings on manufacturing and jobs came in softer than expected. On Thursday, the Institute for Supply Management's manufacturing index for July came in at 46.8%, reflecting contraction and the lowest level since November 2023. New orders were also lower, reflecting weakening demand.

Thursday brought more negative news from the jobs market: unemployment insurance claims for the week ending July 27 were up by 14,000 from the previous week to 249,000. On Friday, the July jobs report showed an uptick in the unemployment rate to 4.3% from 4.1%, the highest since October 2021.

Stepping back from last week's weak data, chief investment officers and top strategists say the market is overreacting, and they're using this as a buying opportunity.

"As markets sell off, all else equal, the return prospects are more favorable, and so we're slowly but surely adding back some of that equity risk that we've been underweight coming into the sell-off," said Philip Straehl, Morningstar Wealth's Americas chief investment officer.

What the economic data really says

The good news is that the jobs reading may not be the new trend but rather a blip, according to an August 4 note from Goldman Sachs' equity strategists. Led by Jan Hatzius, they highlighted one key point: 70% of the uptick in July's unemployment came from temporary layoffs.

Similarly, the manufacturing data is not as foreshadowing as it seems on the surface.

"The ISM number has been weak for about two years, and it hasn't really affected the overall US economy because almost two-thirds of US GDP is actually in consumption within services," said Alicia Levine, head of investment strategy and equities at BNY Wealth. "But the ISM manufacturing data can be a leading indicator of S&P earnings, particularly the new order number."

Levine maintains that the stock market is overreacting. She refers to this sell-off as "a growth scare without a recession." The S&P 500 remains in good shape. The average annual drawdown for the index is 12%; that said, it's still up 9% year to date. Meanwhile, August and September are historically slower for the stock market.

Still, she's bracing for increased volatility as economic data continues to roll in. So what's changed? Mainly the expectation of more rate cuts . Levine is forecasting three cuts through the end of the year at 25 basis points each in September, November, and December for a total of 75 bps. If the jobs report weakens dramatically or comes in under 100,000 jobs created, then we could see as much as a 100-basis-point cut, with 50 bps in September, she said.

Buying opportunities

Levine's playbook is to wait for further downside before she uses this downturn as an opportunity to put capital to work.

Morningstar's Straehl already has an idea of where his team will be hunting for bargains. In this round, he is interested in two key areas: US large caps and Japanese stocks.

Before Thursday, the broad market didn't look too great, but the sell-off created an opportunity to inch back into US large-cap value and growth stocks. Straehl is also watching for buying opportunities in Japan's market, which saw heavy selling due to the spiking Yen. Previously, he had been selling down positions in the Japanese market. But the repricing has caused him to rethink that strategy, with the biggest opportunities being in sectors hit hardest, like export-oriented companies and banks.

For Simeon Hyman, a global investment strategist at ProShares, everything is now cheap except the Magnificent Seven. For the leading Big Tech players, the sell-off only makes a tiny dent in their valuations. The question for him becomes, how do you discern between what was left behind for a good reason versus no good reason? There are many ways to answer that question, but his suggestion is to stick to dividend growers. This way, you're using this as an opportunity to pick up quality stocks, not just those in the bargain bin.

"If you're looking for companies that are more likely to hold up their fundamentals, why not just look at what companies are telling you," Hyman said. "When a company does a buyback, like a lot of tech companies have done, they're telling you they had a good year last year. But when the company increases its dividend, like those dividend aristocrats, they're telling you that they're confident about the future because it's a forward-looking commitment."

Hyman refers to growers as those with increasing dividends for at least 25 consecutive years. Their long track record means they have grown dividends through incredibly difficult environments, including the great financial crisis and the pandemic. The only way they could have done that is by having different dimensions of quality, including cash flow, earnings growth, and an overall strong balance sheet, he noted.

If you're not a fan of dividend stocks but like digging into data, then Donald Calcagni's approach may be more for you. The chief investment officer at Mercer Advisors says this is a good time to hunt for value and quality earners by focusing on the higher numbers on a company's income statement.

In short, investors need to step away from looking at simple price-earnings ratios and browse through a company's revenues and operating profitability to determine how healthy their core business is. As you move down the income statement and factor in line items such as administrative expenses and non-cash items like depreciation, there's more room for manipulation, he noted.

He added that this approach can also be used to find all-cap value stocks in developed markets.

"If you look at non-US stocks and you look at their valuations, they're trading at about 13 times earnings," Calcagni said. "So I would argue that investors should be carefully reconsidering their allocation to non-US equities right now, especially given the fact that the dollar has been pretty strong."