Markets are struggling to rebound from Monday’s sharp sell off, when the Dow Jones industrial average fell 4.6 per cent, its biggest one-day percentage decline since 2011, leaving many wondering what triggered the drop and whether worse is to come. Here’s a look at what’s going on.
1.Why the sell off? Kash Pashootan, CEO at First Avenue Investment Counsel Inc., says it’s a fool’s game to try and explain why a correction took place, but points out there is no arguing that some pullback was overdue after nine years of positive returns for U.S. markets.
Corrections are seen as entirely normal during bull markets, and even helpful in removing speculative froth and allowing new investors to buy into the market at lower prices. The last time the market had a correction was two years ago, which is seen as an uncommonly long time.
2.Why now? It certainly wasn’t because of bad job numbers or other fundamentals, said Benjamin Reitzes at BMO Capital Markets in a note, pointing out that Monday’s only data point showed that the U.S. non-manufacturing sector started the year in robust health. Many point to the strength of the U.S. economy, including Friday’s positive job numbers that showed wages growing at the fastest rate in eight years, as a potential cause. The positive indicators have increased speculation that the U.S. Federal Reserve may raise interest rates faster than expected to cool inflation.
3.How do interest rates affect the stock market? Higher interest rates would push bond yields higher and make fixed-income investments more attractive than they’ve been in a while. That gives investors a viable alternative to stocks that have already raised concerns of being overvalued or presenting a higher risk profile. The rise in interests rates could also in turn slow down economic growth, by making it more expensive for people and businesses to borrow money.
4. How does the TSX compare? Canadian markets have been much slower and steadier in general in the past few years, and the last week has somewhat continued that trend. The Toronto Stock Exchange has experienced a longer seven day decline, but drops have not been as steep as in U.S. markets. It ended last week down four per cent before closing down another 1.7 per cent Monday as the downward pressure on markets around the world takes Canada’s largest exchange down with it.
From last Thursday to Monday the Toronto Stock Exchange’s S&P/TSX composite index fell 3.9 per cent, while the S&P 500 index was off 6.2 per cent over the three days.
5. How significant is the drop? Dan Hallett, vice-president of HighView Financial Group says corrections are a normal part of investing, and that even during this sustained bull market there have been previous speed bumps. He points out that in 2011, U.S. stocks dropped 18 per cent and took several months to recover while Canadian stocks lost nearly 17 per cent and took two years to recover. Both markets saw dips of more than 10 per cent in 2015 that took months to recover. He said these were corrections and not bear markets, which we haven’t seen since the financial crisis.
6. What might this mean for the Canadian dollar? Scotiabank chief economist Jean-François Perrault says that financial volatility usually pushes people to put money back into U.S. treasuries, because it’s possibly the safest and most liquid asset out there. That can mean pulling money out of other asset classes including things like commodities and the Canadian dollar, which has dropped by more than a penny in recent days.