The deal with dwindling markets
Stocks were hit hard this week - can the dip earlier this year indicate what's to come?
Saturday, October 13, 2018 – Print Edition, Page B2

As investors ponder whether the recent bout of stock market turbulence is over, a useful template is emerging: the last bout of market turbulence. But will the pattern repeat?

Stocks were hammered on Wednesday and Thursday, when U.S. indexes suffered their biggest losses since February. The S&P 500, as of midday Thursday, was down 7 per cent from its record high in September, raising the question of whether a buying opportunity was at hand - or more losses.

On Friday, stocks took one step toward stability. The S&P 500 rose 38.76 points, or 1.4 per cent, to 2,767.13, marking its first gains after six consecutive days of losses. The rally followed better-than-expected quarterly profits from large U.S.

banks, including JPMorgan Chase & Co., and upbeat trade data from China.

Canada's S&P/TSX Composite Index rose 97.16 points, or 0.6 per cent, to 15,414.29.

One day of trading doesn't establish a meaningful trend.

But it may suggest that some investors are taking their cues from an earlier downturn this year, when the S&P 500 slid 10 per cent from late January to early April, and then rebounded to fresh record highs within 10 weeks.

One compelling similarity between the two downturns is a technical indicator. In early April, the S&P 500 fell below its 200-day moving average, a move that suggested to some investors that stocks had become deeply oversold. As it turned out, the worst was indeed over: The index rallied from this point.

This time around, the S&P 500 fell below its 200-day moving average on Thursday - and then rebounded.

The similarities don't end there. The earlier downturn, as with the current one, was also driven largely by rising bond yields.

At the start of the year, the yield on the 10-year U.S. Treasury bond was about 2.4 per cent. But as the yield rose above 2.8 per cent, many investors grew nervous that the bond market was signalling rising inflationary pressures, shrinking profit margins and slowing economic activity.

Yield-sensitive stocks such as utilities and economically sensitive stocks such as energy producers and technology were hit particularly hard.

But as bond yields began to coast sideways, generally below 3 per cent, investors accepted the higher yields and regained confidence in the economy.

This time around, bond yields rose from about 2.8 per cent in September to as much as 3.25 per cent this week, marking a fresh seven-year high and reigniting the same concerns over what the bond market was signalling. Some observers said that third-quarter financial results, set to turn into a deluge of reporting next week, would provide clues about how tariffs and rising wages might be cutting into profit margins.

But once again, the yield on the 10-year bond is retreating from its highs. On Friday, the yield fell to about 3.14 per cent, suggesting that perhaps the worst is over.

Stock valuations offer a third clue about whether a rebound will take hold. During the prior stock market downturn, the price-to-earnings ratio for the S&P 500 fell from 23.4 in late January (based on trailing earnings) to a low of 20 in early April, when stocks bottomed out.

Were stocks cheap? Well, no. But this one measure of valuation had hit a one-year low at a time when analysts were still optimistic about profit growth, which suggested that stocks were at least reasonably priced.

This week, the trailing P/E ratio for the S&P 500 fell to 19.9 - its first foray below 20 in nearly two years, according to Bloomberg. To some investors, this was a bargain not to be passed by.

Of course, no one knows whether today's stock market will continue to follow this year's earlier dip and rebound.

David Rosenberg, chief economist and strategist at Gluskin Sheff + Associates, offers the bearish case: He pointed out that most market troughs, going back much further, see valuations decline a lot more than they have this week, a greater percentage of stocks trade below their 200-day moving averages and readings of investor sentiment turn very dark.

"The true capitulation signs are still not quite there, if the recent past can be relied upon as a yardstick," Mr. Rosenberg said in a note.

Some investors, though, are looking at a different recent past.

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