Yippee! Has the correction begun?
The way many Wall Street strategists talk about stock market downturns, you might think they were events to look forward to – like Black Friday sales, but with discounted stocks substituting for priced-to-move TVs and ski boots.
Most corrections, however, are nastier affairs that test the resolve of investors and make stocks look like assets to avoid. As long as investors see the current turbulence as little more than a buying opportunity, you have to wonder if the real pain is still to come.
So far, the damage has been slight in North America. The S&P 500 has fallen 3.3 per cent from its record high at the end of 2013. Canada's S&P/TSX composite index has fallen just over 2 per cent.
That's nothing. The S&P 500 has gone more than two years without suffering a decline of 10 per cent or more, the usual definition of a correction. Over this period, the index has risen more than 60 per cent.
That's an unusually smooth ride and it has fed the view among most strategists that the market is long overdue for a tumble, even as they remain optimistic that the bull market in stocks is alive and well and that the S&P 500 will end 2014 higher than it began.
You can understand where this optimism is coming from. The U.S. economy continues to improve, Europe is stirring to life and Japan is in the midst of an economic overhaul. Things are so good that the International Monetary Fund this week bumped up its estimates for 2014 global economic growth to 3.7 per cent.
Compare this backdrop with previous corrections, and you see that something is missing this time: fear.
Bouts of turbulence in recent years have followed deep concerns about the global economy – most of them related to whether the euro zone was about to fall apart, sending knock-on effects to almost ever corner of the world. This time, the concerns are far less clear and the downside is more difficult to see, making the turbulence look like nothing more than market jitters at this point.
Investors could be growing cautious after U.S. stocks in 2013 delivered their best annual performance since the 1990s. So? U.S. corporate earnings for the fourth quarter have contained some high-profile disappointments so far, but the overall picture hardly suggests a compelling reason to run from stocks.
And emerging-market currencies are declining amid the U.S. Federal Reserve's switch to tapering its bond-buying stimulus program, encouraging investors to send their money stateside. But at this point it is hard to see how a rotation out of emerging markets and into developed markets will hurt U.S. stocks.
This isn't to say that the losses of the past week should be ignored as a trivial matter and that a correction is out of the question.
But if you are looking for a buying opportunity in U.S. stocks, this isn't it – not yet, at least. Valuations, an ongoing concern among bearish investors, haven't budged with the modest decline in prices. More importantly, there hasn't been a noticeable shift in sentiment: Surveys among fund managers and retail investors have been showing a healthy level of enthusiasm for stocks. And without a fundamental shift in the outlook for the U.S. economy or corporate earnings – or, say, a blowup somewhere else – it is difficult to see sentiment changing dramatically.
The prospect of a correction looks like a good thing because it is long overdue and will give investors a chance to buy stocks on the cheap. But a deeper downturn will challenge those assumptions. When you get to the point where stocks look ugly, investors are fearful and the last thing you feel like doing is throwing money at the market, you'll know that a real correction is at hand.
David Berman