Is it a correction or a bear market?


Global risk assets continued their trend of turbulent activity this week as equity markets in the U.S., Europe and Asia averaged +/- 2 percent daily price swings.  The S&P 500 is down 4 percent for the week and just a few points away from marking correction territory (down 10 percent from a recent peak) relative to its market high set at the beginning of October.  The yield on the 10-year Treasury moved to 3.07 percent, shedding nearly 20 basis points as market participants looked for perceived safe-haven of bonds.  A similar trend developed globally as month-to-date returns for developed and emerging market stocks approached the negative 10 percent mark on Friday with some individual markets moving past this key milestone.

It is a correction or bear market?

Experiencing heightened levels of volatility is a normal part of market activity.  Yet, we already went through a correction earlier this year as the S&P 500 moved past the negative 10 percent mark in February and a further pullback in March before staging a rally that lasted through the start of October.  This is notable because since the height of the global financial crisis, market corrections happened less frequently and with shorter duration.  With this increased volatility, is it possible that a bear market selloff (that is, markets being down greater than 20 percent) is in the making?

Correction more likely than a bear market

We believe that the current selloff is likely more indicative of a correction than a full blow bear market.  To this point, we believe that market participants are simply more challenged trying to figure out how today’s events could affect market fundamentals in the future.  This is evident in 1) the geopolitical landscape being more difficult to navigate, 2) central banks moving toward less accommodative policies following a long stretch of “free money” and 3) a general unknown regarding what may tip the U.S. economy into a recession.

To the first point, the U.S.’s decision to enact tariffs on China and its key allies earlier this year not only increased market uncertainty, it marked a notable pivot in U.S. foreign policy from an inclusive actor toward individual actor on the global political stage whose allegiances (once staid) are now in flux.  So, when a dispute between Turkey and Saudi Arabia crop up like it has in recent weeks, an increasingly growing number of investors are not exactly sure how to interpret the market implications of the U.S.’s position of condemning one of its strongest allies.  In other words, reading the political tea leaves is not as simple as it used to be.

Next, in terms of central bank activity, the Federal Reserve has not only ended its asset purchase program and raised rates a from zero percent to over 2.5 percent, policymakers are now debating whether to reduce the size of its balance sheet.  The European Central Bank earlier this week reaffirmed its commitment to reduce its asset purchase program by the end of the year and signaled higher rates next year.  Inflation data out of Japan suggest that the Bank of Japan may also begin to exit its asset purchase program next year.  Asset purchase programs, which effectively supported asset prices as central banks purchased securities in the open market, provided large sums of liquidity to market participants to take greater levels of risk.  Now as the era of “free money” appears to be coming to an end, market participants are still trying to grasp the broader implications of less market liquidity.

Finally, a stronger than expected report on third quarter U.S. gross domestic product (GDP) growth released this week was not enough to pacify market angst.  Put a different way, the positive news is not enough to balance out the growing pessimism towards the economy.  One reason for this point of view is because we have not experienced a recession in nearly 9 years, marking this as one of the longest economic expansions in recent history.  A slowdown in corporate earnings growth (shown in 3Q reports this week) and persistent weakness in the housing market coupled with the Fed’s recent hesitant path towards rate normalization suggest that the expansion may be coming to an end.  Yet, in contrast to the excesses of the housing market leading up to the previous downturn, the factor(s) that may tip the economy into a recession is not clearly evident and this is leading to more cautious posturing by some market participants.

What can we expect?

Simply stating that the reason behind the current selloff is because market participants have a lot to contend with generally understates the gravity of concerns in the markets and evident in recent price action.  With that said, we believe that changes in each of the three factors above could determine whether markets remain in correction territory or progress on to a deeper market selloff. An end to the U.S.-China tariff dispute and a more cautious Fed may give markets the pause they need to see that a US recession is not imminent.  For now, we expect uncertainties related to how these uncontrollable factors to contribute to wide swings in asset prices in the days and weeks to come.

About the Author

Helping people get ahead in life by simplifying complex financial stuff

Be the first to comment on "Is it a correction or a bear market?"

Leave a Reply

This site uses Akismet to reduce spam. Learn how your comment data is processed.