After a Good Run, Markets May be Due for a Correction - Might the Developing Asian Viral Outbreak be the Catalyst?

Jan 24, 2020 | Nick Scholte


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Whatever the answer, corrections are normal and healthy in ongoing bull markets. No overt defensive measures are anticipated, although a concessionary delay in putting past defensive proceeds back to work is being considered.

To my clients:

If you prefer, read this week’s update on my website:

It was a mixed week for North American stock markets with the Canadian TSX finishing up 0.04% (note the extra 0) ; the U.S. Dow Jones Index down 1.2%; and the U.S. S&P 500 down 1.0%.

As I’m sure all will know, there has been a deadly viral outbreak in China with potential to spread globally. Outside of spreading to other Asian nations, there have now been two cases reported in the U.S., and a number of potential cases are being monitored here in Canada. Frankly, it has been the ebb and flow of this developing story that has dictated the path of markets this week and led to the overall decline. Obviously the percolating concern is that some sort of worst case “pandemic” (an order of magnitude greater than an “epidemic”) outcome could meaningfully hinder economic growth. Is this possible? Absolutely? Is it likely? For a variety of reasons (some specific to what we already know about this particular “coronavirus”), the answer is “probably not”. But as medical experts have repeatedly warned over the years, someday one of these epidemics will turn into an actual pandemic. It’s just that it is far too premature to react in any meaningfully defensive way at this stage. Illustrative of why it might be rash to over-react in a defensive way in the early stages of such an outbreak is the following table which examines the past 12 significant global “epidemics”, and how the market performed over the following 6 and 12-month stretches. One will clearly see that negative market outcomes were few and far between.

 

 

The preceding being said, markets have been on an exceptionally strong run since mid-October and, were it to occur, a correction should not surprise anyone. Corrections happen all the time in ongoing “bull” (i.e. up trending) markets. Beyond the fact they should be considered “normal”, corrections might also be considered “healthy” for markets as they temper the impulse for unbridled optimism leading to market bubbles. Market bubbles are a true danger to markets and economies (think the dot-com sector in 2000, and real estate and aggressive mortgage practices in 2008).

So, while a true pandemic resulting from this Asian virus is unlikely, concerns about such an outcome might well linger and trigger a correction in the short term. Markets often need a catalyst for a correction, and this may well prove to be it. Interestingly, I wrote my Q4 2019 letter to discretionary clients earlier this week (it is being mailed today) and in it I stated that I am “almost sure to add back some of the equity removed for defensive measures (earlier) in 2019” if the manufacturing sector (per the ISM index) exhibited a rebound in the first week of February as many of the key regional manufacturing reports appear to be indicating. Depending on the degree to which the virus inevitably spreads over the next week, and how markets react to the spread, my inclination to immediately follow-through on this pledge may well be tempered. In other words, it might be prudent to await a better entry point if a true correction takes hold. Time will tell how this plays out and this is an example of how thinking can change in real time. But to reiterate, overt defensive measures are not suggested and none are being taken. The only potential concession to the viral epidemic might simply be a delay in adding back equity removed earlier in 2019.

That’s it for this week. Despite the unfortunate situation in China right now, let me wish “gung hay fat choy” to my many Chinese clients, and my usual all the best to everyone.

Nick

Nick Scholte, CIM, FCSI

Vice-President & Portfolio Manager

Scholte Wealth Management
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