There is panic in the markets right now, and panic rarely translates into profits.
The S&P/TSX Composite Index started the day down more than 700 points. It then pared most of those losses, before ending down 421 points, or 3.1 per cent. In the U.S., the Dow Jones Industrial Average opened down more than 1,000 points, but by the end of the day shaved off roughly half of its losses, closing down 588 points or 3.6 per cent.
Monday's mid-day recovery was a positive sign as it shows that buyers are ready to step into the market when valuations become compelling and stocks become oversold. However, the late-day selloff was evidence of skepticism by investors. I would say that this caution is warranted.
China is at the heart of the matter and cause for the turmoil in global markets. There was no action taken by the People's Bank of China over the weekend aimed at stimulating the economy, disappointing investors and sending the Chinese markets into a tailspin. On Monday, the Shanghai Stock Exchange Composite Index plunged 8.5 per cent and the Shenzhen Stock Exchange Composite Index declined by 7.7 per cent. The losses spilled over into European markets and then into North American markets.
A tug of war took place over the day on Monday between the bulls and the bears. Fear drove the markets lower, while opportunistic buying helped the markets recover during the trading day. The VIX Index, a measure of fear in the market place, spiked to a reading above 53 earlier this morning, closing at 41. To put this in perspective, the VIX index was at a reading of 15 last Wednesday.
Volatility continues to play out. Margin calls may create further selling pressure. Furthermore, institutional money managers may have to sell stocks, likely their winners, to raise cash positions to ensure there is enough cash on hand to cover redemptions.
No one knows when equity markets will find a bottom. However, for now, the downtrend remains intact. Market corrections tend to occur at a much faster rate than market rallies, meaning that when we do see a recovery, it may be slow and patience may be required.
The market selloff is taking all stocks down, indiscriminately. Today, 97 per cent of stocks in the S&P/TSX Composite Index traded down, with all 10 sectors in the index down.
In terms of valuations, the S&P/TSX Composite Index is now trading at a price-to-earnings (p/e) ratio of 14.7 times the forward 12 months' consensus estimate. This is at a discount to its three-year historical average of 15.1 times, and relatively in line with the five- and 10-year historical averages of 14.5 times. For U.S. markets, the S&P 500 Index is trading at a forward p/e multiple of 15.4 times, and its three- and five-year averages are 15.3 and 14.2 times, respectively. In summary, valuations are reasonable relative to historical levels, suggesting we may soon find some support.
Here is the bottom line: This appears to be a correction within a secular bull market. Markets are forward looking and the underlying economic data are expected to show a slow recovery in North America in 2016. Market volatility will persist in the near-term, creating buying opportunities for long-term investors. Valuations are becoming more compelling, lower oil prices are positive for users of oil, and the U.S. Federal Reserve may be hard pressed to raise interest rates in September with the lack of inflation and global economic unsteadiness. Investors should maintain a disciplined approach, avoiding resource stocks, and accumulate stocks with solid fundamentals with a staggered approach on the market dips.