Stock markets in for further swings, investors try to gauge depth of downturn

TORONTO – Stock markets are likely in for more volatility this week as traders wonder if sharp gains at the end of last week signal an end to what would be a relatively mild retracement — defined as a temporary reversal in the direction of a stock’s price that goes against the prevailing trend — or a full blown correction. That sort of downdraft carves at least 10 per cent from market highs.

“Neither we nor anyone else knows exactly how deep (the declines) will run, (or) how long it will take,” said David Wolf, portfolio manager at Fidelity Investments.

“What we do know is that this has happened before in markets, it will happen again in markets and in the meantime, the key message is don’t panic.”

The TSX ended last week with two back-to-back triple-digit advances for a flat performance on the week after six straight weeks of losses, while the Dow industrials declined one per cent, adding to five weeks of losses.

North American markets have nose-dived since hitting recent highs in September on worries that the U.S. economy was the only bright spot in an otherwise grim global economy and that European powerhouse Germany could slip into recession. Uncertainties also persist over the impending end of the Federal Reserve’s key stimulus program of massive bond purchases.

Markets started sensing capitulation signals at the middle of last week at a point where the TSX was down about 12 per cent from its September highs — two percentage points more than the threshold that marks correction territory — while the Dow industrials had fallen about eight per cent and the S&P 500 more than nine per cent.

The TSX is now down nine per cent from the September highs.

At the same time, there seems to be general agreement that the correction was long overdue. New York markets hadn’t seen a correction in about three years while Toronto valuations, particularly in the energy sector, were looking stretched.

“Corrections are part of the normal market environment,” Wolf said.

“It’s quite understandable that they elicit a fearful, even panicky reaction among many which often leads to a three or four per cent drop turning into a six, eight, 10 per cent drop. But from our lens, unlike say in 2008 . . . in this case the global economy isn’t doing great but it’s still growing, led by the U.S.”

Wolf is optimistic and thinks his view will be borne out when third-quarter U.S. gross domestic product data is released next week. He thinks GDP could rise at an annualized pace of about three per cent.

“Not bad. That comes after a reasonably strong second quarter, (but) you have other parts of the world frankly not looking so hot,” he added.

One major bit of fallout from the sharp market losses has been that the slew of corporate earnings in the U.S. over the last couple of weeks has failed to move markets one way or another.

“Most people haven’t been focused on that,” said Wolf.

“I think the lack of reaction to earnings . . . is very emblematic of sentiment in the market. (Bad news) will eventually run its course and there’s enough good news out there, at least in our opinion, that it will eventually gain the upper hand again.”

The Canadian corporate earnings season also starts to move into high gear this week with railways Canadian National (TSX:CNR) and Canadian Pacific (TSX:CP) reporting Tuesday. Energy giants Cenovus (TSX:CVE) and Husky (TSX:HSE) post results Thursday.

Meanwhile, Canadian investors will look to the Bank of Canada’s scheduled announcement on interest rates on Wednesday. No one expects the central bank to hike its trend-setting rate until sometime late next year from one per cent, where it’s been since September 2010. But markets will be looking to the announcement, and subsequent news conference by bank governor Stephen Poloz, for any hints about the timing of future hikes.