It’s been a wild ride on the stock market this week.
Monday saw heavy losses in both the U.S. and the Canadian equities markets, with the Dow Jones Industrial Average posting the largest-ever points drop in history.
That meltdown gave way to a day of volatile trading on Tuesday, with prices swinging wildly between gains and losses and eventually almost recouping the lost ground. It’s only the second day of the workweek, but stock traders must feel exhausted.
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What about everyday Canadians, though? What does this crazy market ride mean for small investors and what does it say about the economy at large?
Here are a few takeaways:
This isn’t the start of a new recession
“Just because the stock market is down, doesn’t mean it’s 2008-2009,” said Brian Belski, chief investment strategist at BMO Capital Markets. Rather, the recent drop is “an overdue correction,” he added. Most of the market research reviewed by Global News is in line with Belski’s take: Many stocks were looking a little too pricey lately, so this drop is helping bring things back in line with reality.
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There is no sign so far that the stock market rout is spilling out into the wider economy. On both sides of the border, the economy is growing, companies are doing brisk business, and unemployment is at record lows. If anything, it’s the economic good news that seems to have triggered the stock market pullback.
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In particular, the catalyst for the sell-off, which started on Friday, was likely the release of data that showed better-than-expected wage growth in the U.S. Climbing wages mean extra costs for businesses, which often react by raising prices for customers, feeding inflation. That helped stoke investor worries that the U.S. central bank, the Federal Reserve, might want to raise interest rates faster than investors had expected. (Central banks generally use higher interest rates to help keep inflation in check.)
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“U.S. interest rates are likely to increase at a faster pace than the market had anticipated with three to four hikes in 2018 the more probable scenario than the two hikes that had been priced in,” according to a note that Toronto-based financial firm TriDelta Financial sent to clients on Tuesday.
And higher interest rates, in turn, have implications for stocks. “Higher rates, it is believed, could reduce liquidity, increase borrowing costs and make bonds a more appealing investment,” reads the TriDelta memo.
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Algorithms and human inexperience likely made things worse than they needed to be
While these concerns probably set the stock selling in motion, it looks like things quickly snowballed into a surprisingly steep market dive. A possible reason for this, according to several commentators, is that the market decline triggered a number of automatic sell orders. Investors can limit their losses by setting trading programs to sell certain portfolio holdings if prices drop below a certain level, or if other market indicators cross certain thresholds. This may have contributed to “many good companies having been sold indiscriminately, regardless of their underlying fundamentals, earnings growth expectations and valuations,” TriDelta said.
Indeed, the fact that stock indices rebounded after the initial plunge may partly reflect an effort by investors to buy back some of those good stocks.
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But humans are also to blame for the overreaction, according to Belski. “The biggest problem with what’s happening right now is that the majority of investors lack perspective,” he told Global News. Many of those who are running portfolios or writing stock market research these days have less than 10 years of experience, Belski said: “They’ve never seen a proper bull market, and they’ve never seen a fundamental correction.”
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Stocks will probably bounce back
The current plunge is just a temporary rough patch, Belski said. “In 2009 I came out and said, U.S. equities have entered a 20-25 year bull market. That has not changed,” he told Global News.
TriDelta shares a similar perspective. While the recent stock market sell-off was “sharp and sudden,” its magnitude was by no means unprecedented. The Dow, for example, has dropped more than seven per cent since Friday, but equity markets often see declines of five per cent or more – and sometimes 10 per cent or more – and still manage to generate average annual returns of approximately 10 per cent, the firm noted.
“We ultimately expect equity returns to be positive in 2018, but with considerably more volatility than last year. Despite this sell-off, based on the strong economic and earnings growth projections for this year, we have no reason to change this view,” said TriDelta.
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