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Market corrections do not equal recessions

06 September 2019

4 minute read

By Gerald Moser, Chief Market Strategist

Placing too much faith in financial markets’ ability to call recession can lead to a bad investment strategy. So, should investors take heed of the latest bout of extreme market pessimism, or ignore it and stay invested?

Financial markets more volatile than the economy

Paul Samuelson, an American economist recipient of the Nobel Prize in Economics in 1970, once famously said: “The stock market has forecast nine of the last five recessions.” His point was that financial markets are prone to extreme behaviour. Sentiment can shift from too pessimistic to too optimistic relatively quickly, and this can lead to investors positioning for a recession which ultimately does not materialise in the short term.

The above behaviour creates so-called “bull market corrections”, when growth-driven assets experience a fall in an overall up-trending market. August’s market movements, with equities selling-off and the 2-10-year yield curve inverting, bear the hallmark of a coming recession. However, we think it is too early to call for an end of the current cycle.

Bull market corrections chart

Market jitters return

Over the last month, growth-sensitive asset classes, such as commodities and equities, suffered from a second drawdown this year, the first sell-off occurring in May. On each occasion, global equities lost around 6% in value.

In our Market Perspectives back in April, we highlighted that we expected this year to be challenging with a few sell-offs creating tactical opportunities. While we have already had two market drawdowns, we think more jitters may shake financial markets later in the year. But this would likely be triggered by geopolitical tensions rather than the start of a recession.

Anatomy of bull market corrections

Although bull market corrections are stressful and can shake convictions, they are not uncommon. In fact, since 1988, and excluding years when there was a recession, the average largest correction in any year is around 10%.

The trigger of corrections can be difficult to identify: they may be caused by a string of bad economic data, geopolitical tensions, profit taking after a strong market performance or central bank actions. Even in hindsight, it is sometimes difficult to explain violent market sell-offs.

Another feature of corrections is that they are short-lived. They normally last one to three months and markets usually recover equally rapidly. As identifying catalysts for corrections is hard to identify, and they are often short-lived, it becomes clear that it is extremely difficult to time a bull market correction. In that respect, when we mention tactical opportunities, we refer to opportunities for investors that are not yet invested as well as volatility-based opportunities.

Stay invested

For that reason, we believe that it is better to stay invested through volatile times, as getting market corrections’ timing right is nigh on impossible.

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Market Perspectives September 2019

Find out our latest key investment themes. Expectations of more dovish central bank policy could do nothing to prevent a sharp, negative, swing in senitiment in August as recession fears returned to markets. Furthermore, US-China trade tensions seem unlikely to be resolved soon.

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