Stocktake: Correction time for stock markets

This is still a bull market, so it’s wise to give stocks the benefit of the doubt

September has lived up to its reputation as the ugliest month of the year for stock markets, with the S&P 500 suffering its first double-digit correction since the bull market began last March. Many commentators had warned that stocks were ripe for a pullback. A five-month gain of over 50 per cent represented the S&P 500's best-ever start to a new bull market. Until last week, notes Bespoke Investment, there was only one day since mid-April where fewer than half of S&P 500 stocks closed above their 50-day moving average.

August’s excesses were especially marked, leaving markets in extremely overbought territory. That excess has now been unwound; last week, only 25 per cent of stocks were trading above their 50-day average.

Non-US indices were nowhere nearly as overheated, but they have not been spared; European indices hit three-month lows while the average stock market was 2.43 per cent below its 50-day average, says Bespoke, the lowest reading since April.

Run-of-the-mill corrections tend to end when around 15 to 20 per cent of stocks are trading above their 50-day average. That said, things may get worse before they get better. The recent sell-off began as an attempt to correct obvious excesses in gravity-defying technology stocks.

Softening economic data and renewed coronavirus fears mean the narrative has shifted somewhat. As Bloomberg's John Authers put it: "This wasn't so much 'we took things too far' as 'we might have taken things in completely the wrong direction'."

This is still a bull market, so it’s wise to give stocks the benefit of the doubt and to bet we’re not about to fall back into bear market territory. Nevertheless, October may well be another nervy affair.