I Reiterate, Corrections are a Normal Part of Market Behaviour

Oct 01, 2021 | Nick Scholte


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The title notwithstanding, what might have contributed to the September weakness in markets? In this era of heightened U.S. political disfunction, certainly debt ceiling negotiations played a role.

To my clients:

It was a down week for North American stock markets with the Canadian TSX finishing down 1.2%; the U.S. Dow Jones Index down 1.4%; and the U.S. S&P 500 down 2.2%.

From time to time in these weekly updates, I remind clients that corrections are a normal part of market behavior and that trying to time them is nearly impossible. In fact, I’d go further and suggest that consistently timing corrections is impossible. As a reminder, a “correction” is typically defined as a market decline of 10 to 20% from a recent peak. On average, a correction happens approximately once per year.

Market declines of at least 5% are even more frequent, occurring up to 3 times per year on average. Depending upon the market index one looks at, the weakness seen in September either qualifies as one of these more frequent 5% corrections, or is knocking on the door.

I remain steadfastly committed to the notion that equities should be given the benefit of the doubt unless recession is imminent. As I argued in my September 17th post (see here), recession is nowhere in sight, so adhering to the belief that short-term market corrections cannot be consistently timed, portfolios have not seen their equity (i.e. stock) allocations adjusted lower in the face of recent market weakness. Even today, the ISM Manufacturing Index (one of the Big 3 economic indicators I track) again came in at yet another exceptionally strong reading of 61.1. Anything over 60 indicates very robust and expansionary manufacturing activity.

Then notwithstanding the preceding, what may have contributed to the September weakness? Inflation concerns are certainly a factor, but see my rebuttal to this narrative in last week’s update here. The other factor which I have yet to discuss (so far in 2021), but which is a recurring concern the markets face every handful of years is the need to raise the U.S. debt ceiling limit. Keeping things simple, I’ll simply observe that in order to meet its fiscal obligations, the U.S. is periodically forced to raise this limit so that it does not default upon its debt. A debt default by the world’s largest economy and issuer of the de facto global reserve currency would be catastrophic.

Further, as the U.S. political climate becomes ever more polarized, negotiations to raise the debt ceiling in recent years have morphed into a recurring game of political brinkmanship. This time ‘round, the drama is further heightened by infighting within the Democratic Party itself as progressives within the party battle centrists for control of the political agenda. But here is the rub: despite the ever growing chasm between Democrats and Republicans, the fact is that Democrats control both chambers of Congress and the Presidency. The Democrats can raise the debt ceiling unilaterally if they wish. If common ground cannot be found with Republicans, would Democrats really let the nation default on its debt because of internal squabbles? That would be a surefire way to get decimated in next autumn’s mid-term elections, and likely the Presidential election two years thereafter. I just don’t see it happening. Will it go down to the wire with the Republicans to get a bipartisan deal done? and/or internally within the Democratic party for control of its future direction? Almost assuredly yes in both cases, with associated market jitters to match. But I believe it would be unwise to shift portfolios defensively in anticipation of a low-likelihood deffault outcome.

That’s it for this week. All the best,

Nick

Nick Scholte, CIM, FCSI

Vice-President & Portfolio Manager

Scholte Wealth Management
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