- The sell-off in US stocks reached correction territory on Thursday, with the S&P 500 falling as much as 10% from its September 2 high.
- The tech-heavy Nasdaq 100 index entered correction territory on September 8.
- While the sell-off could just be another “normal correction,” investors should brace for the possibility of the opposite, DataTrek said in a note on Thursday.
- DataTrek outlined three reasons the sell-off could be more than a normal correction and could accelerate.
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Risk management is a core competency of many successful investors, as outsize long-term gains can come from limiting drawdowns in the short term.
But risk management is also hard, as investors tend to focus on the main catalyst that could start a sell-off in the market and not the second- and third-order effects of an uncertain environment that catalyst would create, DataTrek cofounder Nicholas Colas explained in a note on Thursday.
Therefore, while the current stock market sell-off may just be another “normal correction,” investors should prepare for it to not be that, Colas said.
The S&P 500 briefly entered correction territory at its intraday lows on Thursday, falling 10% from its September 2 high.
The tech-heavy Nasdaq 100, which has led US stocks lower since its peak on September 2, entered correction territory on September 8.
DataTrek outlined three reasons the current sell-off could be more than just a normal correction.
1. "US politics."
There is a scenario "where a contested election locks up Washington for weeks or more and no matter which party wins the bad blood between them only gets worse," Colas said. While in "normal times" this wouldn't matter, it does now, since the US economy is weak and many are hoping for another round of fiscal stimulus from Congress.
Colas noted that this has happened before: October 2008 to March 2009, when the country had a high-profile election amid a declining economy. US stocks didn't bottom until one month after the passage of a stimulus package that helped stabilize the economy.
2. "COVID next round."
"If – and this is a big 'If' – markets are starting to discount another wave of societal concern about COVID (which would hit consumer confidence and spending), that would put the [market] recent choppiness into an entirely logical context," Colas said.
With COVID-19 daily cases rising in recent days, investors will likely want to have a backdrop of confidence that the government can help contain another wave of cases. This could be a challenge given point No. 1, Colas said.
3. "Unknown unknowns."
"As much as we've been bullish on stocks because we see a textbook cyclical earnings recovery on the way, we also understand that the global economy is fragile just now," Colas said. "That leaves little room for absorbing another shock, whether it be financial or geopolitical."
Still, he said the bullish argument that would dismantle all three points above is simple: A successful COVID-19 vaccine is developed, more fiscal stimulus is passed, and the election result can't be contested.
"These issues are transitory rather than structural," Colas concluded.
