Thursday, May 20, 2010

How big will this correction be?

The S&P 500 entered into correction territory today by dropping 43.46 points or 3.9% to close at 1,071.59 points. The definition of a correction is a 10 percent drop from the market highs, and the S&P 500 has declined 11.12% from its 2010 high of 1,205.03, reached on April 26.

The TSX, on the other hand, has been slightly stronger over the same period. With today's fall of 259.82 points to close at 11,405.95, the TSX has declined 7.43% from its 2010 high of 12,321.76 on April 27. Thus, the TSX has not reached correction territory.

The TSX has outperformed the S&P 500 during this period probably because of the relatively better debt situation in Canada compared to the US. With the implosion of the government debt problem in Greece and its affect on the rest of the EU, some have begun to warn that the US could eventually be in the same situation if its national debt continues to increase at the present rate.

The story is simply that the debt crisis that began in Greece has triggered significant losses in stock markets around the world. The question now becomes: How big is this correction going to be? David Rosenberg stated today that he expects the correction to be 31%. His views are consistently bearish, and his predictions have not been the most accurate since the market bottom in March 2009. I believe that, with the current market condition, the TSX will experience a correction just slightly greater than 10%, which puts the index slightly lower than 11,089.58. However, if the situation worsens (e.g. the EU and IMF bails out another country/countries) then the decline in the TSX could be greater.

A silver lining is that, according to Bespoke, currently only 7% of S&P 500 stocks are above their 50-day moving average (50 DMA), while 93% are below their 50 DMA. This is the lowest level since March 2009, when the reading was 5%. What followed, of course, is one of the greatest rallies since the Great Depression.

Another silver lining is that the debt crisis in the EU now makes a June 1st interest rate hike by the Bank of Canada much less likely. This is positive, since high interest rates are always bad for the stock market.

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