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Last week can only be described as brutal. No matter where you looked, the numbers were negative as investors fled for the hills. On Friday morning, RBC Capital Markets reported that global equity losses since China's currency devaluation exceeded $3.3 trillion. The plunge continued through the day, wiping out billions more in paper values.

And there could be worse to come. Last week, London's Daily Telegraph published a gloomy article listing eight reasons why world stock markets are on the verge of a full-scale crash.

Written by John Ficenec, the story focused on the economic slowdown in China and its resulting impact on world commodity prices as the prime reasons for concern. But it also warned that central banks are running out of weapons to deal with another economic setback and cited some ominous statistics.

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One was the fact this bull market has run for 77 months, longer than any others except for the years leading up to the crash of 1929 and the bursting of the dot-com bubble in 2000. Another was the elevated level of Prof. Robert Shiller's cyclically adjusted S&P 500 price/earnings ratio, which is 64% above its historic average. "On only three occasions since 1882 has it been higher — in 1929, 2000, and 2007", Mr. Ficenec wrote.

Worrisome stuff indeed! However, what the story left out of the equation was the potential countervailing effect of the gradual but discernable recovery in the world's largest economy, the United States. It's unthinkable that the savants that make up the Federal Reserve Board's Open Market Committee would raise interest rates, as they appear poised to do, if they seriously believed global stock markets were on the verge of collapse.

Still, there are enough negative forces in play right now to cause concern and the plunge in the markets last week reflected that. While I don't believe we're heading for a repeat of 2008, the recent losses have pushed the TSX into official correction territory. The S&P/TSX Composite Index ended the week at 13,473.67, down 14.1% from its 52-week high of 15,685.13. A drop of 10% or more qualifies as a correction; a fall of 20% signals a bear market.

The U.S. market hasn't fared quite as badly although the Dow moved into correction territory after its 531-point decline on Friday. It is off 10.3% from its all-time high of 18,351.36 set earlier this year. The S&P 500 is down 7.7% from its 52-week high of 2,134.72. But if the current trend continues, it too could be in correction mode before long. Remember that, historically, September is the worst month of the year for U.S. markets.

These results should not come as a surprise to readers. I have warned several times in recent months that we were heading for a correction; all that was unknown was the timing.

Faced with this kind of uncertainty, the temptation is to be out of stocks. But we know from experience that market timing is a fool's game. No one that I know of has ever mastered it.

The best option is to make your portfolio more shockproof. You can do that by increasing the cash/bond portion of your asset allocation and adding defensive stocks to the equity side. Those stocks are not immune to risk, but the downside potential is less than that of the broad market. For example, during the 2008 plunge the shares of Fortis Inc., a classic defensive stock, fell about 24%. That was far better than the TSX Composite, which lost about half its value from peak to trough.

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So hold some bonds and cash, add some defensive stocks, and prepare to hunker down for the next few months.

Gordon Pape is Editor and Publisher of the Internet Wealth Builder and Income Investor newsletters. For more information and details on how to subscribe, go to www.buildingwealth.ca.

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