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Is the Mini-Correction a Preview of What’s to Come?

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Buckle Up!

Sometimes it helps to take a pause before jumping into an analysis of a traumatic event. A slight window provides some perspective, allowing an observer to take the time to draw a clearer picture than possible in the heat of a frantic moment such as the onset of the recent stock market tumult.

The headlines ten days ago would give a nervous investor pause: The Dow Lost Over 1300 Points in Two Days’ telegraphed a barely necessary re-cap of what had happened. Another barely necessary headline said ‘Investors Worried’ as if anyone needed to be told that investors had become worried about the market plunge. And for those who had tried to forget February’s stock market tumult, ‘Worst Plunge Since February’ provided a quick comparison.

Undoubtedly some individuals considered a re-calculation of investment or short-term spending plans while most professional advisors (quite correctly and appropriately) urged them to stay the course. Panic, while never constructive, and usually a counter-productive basis for decision-making was an understandable reaction as otherwise bright and shiny market icons like Microsoft, Intel, Apple and Facebook dropped. (Facebook, of course, had unrelated ongoing considerations, such as its massive data breach and member complaints.)

Still, the quick and brutal plunge and the headlines left many investors looking for an explanation and trying to understand its possible effect on their financial position.

First, let’s understand what did happen and did not happen. Generally, the events of ten days ago qualify as a correction but not a crash. A market correction is defined by a movement of 10 per cent or more, explains Jay Nash, Senior Vice-President, Portfolio Manager and Investment Advisor at the London branch of National Bank of Canada. Within that definition, much of Europe and Asia suffered a correction and the NASDAQ fell by 10.5 per cent during intraday trading. Nash points out that the selling was widespread and across most trading sectors. We can call it a plunge that was a temporary correction. It was not, as some panicmeisters suggested, the beginning of the road to another 2008.

Rising interest rates and uncertainty over China trade certainly contributed to the plunge. Moreover, in the days before the plunge/correction, there had been a nervousness on Wall Street, driven mainly by the rising yield on government bonds.  On the other side of that proverbial coin, rising interest rates brought concerns about higher corporate debt as well as higher mortgage and car loan rates. Fears of slowed growth — while eminently logical — added to the downward pressures.

A full correction, which Nash and other advisors have anticipated for some time, appears unlikely during 2018, given strong economic data and historical lows in unemployment.

While volatility is likely to be higher in coming months, November and December are historically strong months and that also contributes to hope for avoiding a correction this year, Nash suggests.

Journalists sometimes refer to the need to have a precise definition as ‘trying to nail jelly to a wall’, and perhaps precisely defining volatility and its causes fits that definition.

Moreover, investors’ reactions to volatility appear to vary depending on the type of investment involved. Nash believes that investors are more likely to hold individual stocks through a market correction than index-based Exchange-Traded Funds (ETF’s). However, investors selling their ETF’s may provoke a trend and lead market makers to sell off individual equities. This can create significant volatility such as happened with Canadian preferred shares in 2015.

However, at any time, a widespread reaction to market weakness or a world event is likely to result in a much larger correction than actually warranted, Nash explains.

A stock market fact of life adds to the horror of the plunge: market plunges usually happen quickly and brutally but the recovery is always much slower, a truism generally proven by the drop in January and February and yet to be proven in the current situation. Nash describes the process at that time — in terms of the S&P 500 — as markets finding a bottom within three weeks, testing that level for three weeks and then taking until April to recover.

Related: Before You Fall in Love with Online Trading

A Nobel prize winner may have the explanation. Most human beings “feel” financial loss twice as much as gain according to Daniel Kahneman, a psychologist noted for his work on the psychology of judgment decision-making and behavioral economics, accomplishments that earned him a Nobel Memorial Prize in 2002.

In effect, when we feel pain our reaction is to move away from it. In this way many investors are hard-wired to sell when things go down and be cautious as the world stabilizes, Nash explains, adding that this produces fast drops and slow recoveries.

For a nervous investor (or even a not-so-nervous investor) coping with this means ensuring one’s ability to absorb loss when investing and being prepared to buy into a market drop.

However, that strategy has to be tempered with a healthy dose of skepticism about price drops. As mentioned in earlier editions, two of the most frequently abused words in the entire lexicon of investing are ‘buying opportunity’. A sharp drop does not necessarily mean such an opportunity.

Where does that leave us for 2019 – which is closer than it sounds and appears to promise continued volatility combined with forecasts for slowed growth?

As Officer ‘K’ says in Blade Runner 2049: Buckle up!

Disclosure: I do not hold any units in any of the investments mentioned in this article and have no plans to purchase any of them.

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