U.S., Canadian stocks plunge as 'stealth correction' gathers strength

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Recent turbulence at the fringes of global markets turned mainstream on Thursday, as U.S. stocks suffered their worst setback in nearly two months amid concerns about monetary policy and the global economy.

The declines reinforced some of the points made by cautious market watchers in recent months, who have noted that high valuations and an unusually smooth ride for stocks over the past three years was bound to lead to some bumps.

"What we're seeing right now isn't a big surprise," said David Rosenberg, chief economist and strategist at Gluskin Sheff + Associates. "You had to have been on an extended vacation to not figure out that we've already been experiencing a 'stealth' correction, even before today's negative action."

The S&P 500 fell 32.31 points or 1.6 per cent, to 1,965.99, for its worst one-day dip since the end of July.

The blue-chip Dow Jones industrial average fell 264.30 points or 1.5 per cent, to 16,945.80. All 30 stocks in the index fell, highlighting a widespread retreat.

Stocks in Europe also fell sharply. In Canada, the S&P/TSX composite index fell 227 points or 1.5 per cent, to 14,893.57.

The benchmark S&P 500 touched a record high just a week ago, and is now a little more than 2 per cent below that peak.

For Canada's benchmark, the damage in September adds up to nearly 800 points, or 5 per cent.

The broad nature of the downturn is bound to raise questions about whether this marks a turning point in the bull market.

There was no clear cause for the sudden retreat.

Reports on U.S. durable goods orders and jobless claims added to evidence that the economic recovery is on track.

On Friday, economists expect a report on U.S. gross domestic product will show that the economy expanded by 4.6 per cent in the second quarter, at an annualized pace – blistering growth relative to most of the rest of the world.

Good news on the U.S. economy adds to expectations that the Federal Reserve will start to raise its key interest rate, perhaps in mid-2015, ending a zero-interest rate policy established in 2008.

But outside the United States, the economic outlook is discouraging.

The euro zone is showing no growth, while Japan's economy contracted in the second quarter.

In China, there are concerns that the country will miss its target of 7.5 per cent growth this year, potentially marking its slowest expansion since the global recession in 2009.

The divergence between the U.S. economy and the rest of the world is "perhaps the most important economic theme for financial markets heading into the fall," said Douglas Porter, chief economist at BMO Nesbitt Burns, in a note.

Commodities reflect some concern about this divergence. Prices for key industrial metals, including copper, have turned down. Crude oil has fallen nearly 14 per cent since June.

Emerging-market stocks, high-yield bonds and small-capitalization stocks have also been weak – forming what Michael Hartnett, chief investment strategist at Bank of America, called "lead indicators of shifts in the economic- and interest-rate cycle."

He believes these indicators point to rising volatility.

Thursday's turbulence stands out because stocks have enjoyed a remarkably long run of steady gains with a notable absence of setbacks.

The S&P 500 has not fallen by more than 10 per cent – the standard definition of a market correction – in about three years, while rallying 80 per cent over this period. Markets usually correct every year.

The gains have contributed to some market distortions. Robert Shiller, the Yale University economics professor, noted in August that U.S. stocks were hovering at "worrisome" levels reminiscent of peaks in 1929, 1999 and 2007.

Mr. Rosenberg argued that the decline of small-cap stocks weeks ago and a deterioration in market breadth – where fewer and fewer stocks drive the S&P 500 – defined a stealth correction and offered the clearest signs of trouble ahead.

However, he believes stocks are in a normal corrective phase that will see declines ranging between 5 per cent and 20 per cent, cleaning out some of the froth rather than ushering in a dreaded bear market.

"Once the valuation levels are restored, we're going to see a very good buying opportunity by the end of the year," Mr. Rosenberg said.