January saw the largest equity correction since the dramatic March 2020 COVID sell-off. In January, US and Australian stocks both briefly touched the 10% “technical correction” level. Both markets have rebounded off their correction lows, though volatility is persisting. Other markets such as the UK, Europe, and emerging markets (EM) have all experienced shallower corrections.
While a US equity correction was well and truly overdue, investors are understandably concerned that the recent “short-sharp” correction could morph into something deeper and longer.
The hawkish shift in Fed policy rhetoric is making investors nervous, particularly when it is occurring against a backdrop of a 40-year high in the US headline inflation rate. Comments from a number of high profile “perma-bears” that the US market is set to crash are nothing new but tend to get more airtime when markets are under pressure.
While the debate around whether the recent pullback represents a temporary correction or the start of a more protracted bear market phase will undoubtedly continue for a while yet, we would emphasise the following points:
- “Corrections” are quite common even in bull markets (See exhibit 1). Based on historical patterns, a US and Australian equity “correction” was well and truly overdue.
- Genuine bear markets occur fairly infrequently relative to corrections.
- Bear markets have almost always coincided with (US) recessions.
- US recessions almost always coincided with a “significant tightening” of Fed policy.
- A tight policy backdrop is not currently in place. Policy is beginning to tighten but remains very easy.
- Even looking ahead 12 months, policy is still likely to be on the easy side of neutral.
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Written by
David Cassidy, Head of Investment Strategy
David is one of Australia’s leading investment strategists.