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Correction: Signs of doom have been greatly exaggerated

What do the stock markets and newspaper writers have in common?

We both flinch at the word "correction."

While I haven't written anything I've regretted lately (knock on wood), the Canadian market crossed an official level of regret last week, when the losses in its current downturn briefly surpassed the 10-per-cent level. This is the threshold for what market watchers deem a full-fledged market correction.

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"The weakness has investors understandably skittish regarding the prospects for the summer and beyond," wrote strategist Craig Basinger of Macquarie Private Wealth in a note to clients.

But corrections are neither rare nor signs of doom. Most are what the name implies - healthy pullbacks that clean up overstretched markets and position them to resume their gains.

The common correction

The S&P/TSX composite has suffered a 10-per-cent-plus correction in 21 of the past 30 years (excluding this year). Yet in those three decades, only nine times has the index finished down for the full year. Yes, all nine of those years had a correction, but that still leaves 12 years that had corrections and still posted positive returns by year end.

Consider, too, that the price-to-earnings ratio on the S&P/TSX composite has retreated from a historically expensive 18 times estimated 2011 earnings at the start of the year to about 14 times now. This, taken on its own, suggests that this is a case of a healthy correction. Yet there are underlying factors at play here which emerge when you take a close look at the differentiation among market sectors during this correction.

Looking under the hood

The weakest performance - in the tech sector - is largely explained by the troubles of a single, dominant company: Research In Motion Ltd. After that, the leaders and laggards paint an interesting picture.

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The most resilient stocks have been in the traditionally defensive sectors - telecoms, utilities, consumer staples - reflecting the broader movement in all asset classes away from risk. The deep losses in energy and materials speak to both the de-risking and the fading global economic picture that have delivered a blow to commodities, and by extension hit the earnings expectations in these sectors that may have become overdone.

Two other sectors stand out to me.

The financial sector is down only modestly, even as the Greek debt crisis has dragged down banking shares in much of the rest of the world. This suggests that foreign investors are still looking on Canada's banks as an oasis of safety - and a potential pocket of strength in Canada's market.

Industrials have also proven resilient, despite the sputtering economic recovery. It could be that this group is seeing a silver lining in the retreat in commodities - namely, some welcome relief on the cost side that could prop up earnings.

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About the Author
Economics Reporter

David Parkinson has been covering business and financial markets since 1990, and has been with The Globe and Mail since 2000. A Calgary native, he received a Southam Fellowship from the University of Toronto in 1999-2000, studying international political economics. More

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