3 reasons why the current stock market sell-off could be more than a normal correction, according to DataTrek
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- The current sell-off in US stocks reached correction territory on Thursday, with the S&P 500 falling as much as 10% from its September 2 high.
- The tech-heavy Nasdaq 100 index entered correction territory on September 8.
- While the current market sell-off could just be another “normal correction,” investors should brace for the possibility of the opposite, DataTrek said in note on Thursday.
- Here are three reasons why the current market sell-off could be more than a normal correction, and instead could further accelerate, according to DataTrek.
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Risk management is a core competency of many successful investors, as outsized long-term gains can come from limiting drawdowns in the short-term.
But risk management is also hard, as investors tend to focus on the main catalyst that could start a sell-off in the market, and not the second- and third-order effects of an uncertain environment that catalyst would create, DataTrek co-founder Nicholas Colas explained in a note on Thursday.
Therefore, while the current stock market sell-off may just be another “normal correction,” investors should prepare for it to not be that.
The S&P 500 briefly entered correction territory at its intraday lows on Thursday, as it fell 10% from its September 2 high.
The tech-heavy Nasdaq 100, which led US stocks lower since its peak on September 2, entered correction territory on September 8.
Here are three reasons why the current market sell-off could be more than just a normal correction, according to DataTrek.
1. “US Politics.”
There is a scenario “where a contested election locks up Washington for weeks or more and no matter which party wins the bad blood between them only gets worse,” Colas explained. While in “normal times” this wouldn’t matter, it does today since the US economy is weak and many are hoping for another round of fiscal stimulus from Congress.
Colas noted that this has happened before, pointing to the period of October 2008 to March 2009, when the country was in the midst of a high profile US election amid a declining economy. US stocks didn’t bottom until one month after the passage of a stimulus package that helped stabilize the US economy.
2. “COVID Next Round.”
“If – and this is a big ‘If’ – markets are starting to discount another wave of societal concern about COVID (which would hit consumer confidence and spending), that would put the [market] recent choppiness into an entirely logical context,” Colas said.
With COVID-19 daily cases on the rise in recent days, investors will likely want to have a backdrop of confidence that the government can help contain a second wave of the virus. This could be a challenge given point No. 1, according to DataTrek.
3. “Unknown unknowns.”
“As much as we’ve been bullish on stocks because we see a textbook cyclical earnings recovery on the way, we also understand that the global economy is fragile just now. That leaves little room for absorbing another shock, whether it be financial or geopolitical,” DataTrek said.
Still, DataTrek noted that the bullish argument that would dismantle all three points above is simple: A successful COVID-19 vaccine is developed, more fiscal stimulus will be passed, and the upcoming election will deliver a verdict and not be contested.
“These issues are transitory rather than structural,” Colas concluded.