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Over the past few weeks, US equity markets have experienced the first meaningful correction since this new bull market began in March. The S&P 500 is down about 7% from its recent all-time high, while the NASDAQ 100 is down about 11%. Gridlock on the next US stimulus package – combined with election year uncertainty – suggests there could be more downside in September and October, according to Mike Wilson from Morgan Stanley.

Key quotes

“We think this correction is just that, a correction in a new bull market. It’s normal for markets to pullback after such an incredible run like we’ve experienced since March. Furthermore, when a new bull market coincides with a new economic cycle, the bull market usually runs for years, not months. The correction is being led to the downside by the biggest winners, namely technology stocks and other beneficiaries of the COVID-19 lockdown. This recession and recovery have been steep and sharp, representing what can only be described as ‘V-shaped’ at this point. If one truly buys into this view, however, then it would make sense that stocks that benefit from the lockdown would be the most vulnerable in a correction.”

“On the correction, there’s still downside as markets digest the risk of congressional gridlock on the next fiscal deal. While we think something will ultimately get done, it will likely take another few weeks to get it over the goal line, which should keep markets nervous in the short term. Importantly, once the deal passes, the risk will shift to higher long-term interest rates, which have been a major support to the rally so far, and the preference for large cap growth stocks.” 

“It’s an election year and historically, US equity markets have traded poorly in the months of September and October. Specifically, these months have been down about twice as often as they’ve been up, and the moves have been significant in many cases. With this year’s election looking close, we expect uncertainty to remain high.”

“My experience with market corrections usually has me lean on technical analysis. On this front, it’s easy to see that equity markets became very extended in August and well above key technical support levels. In fact, even after the recent correction, support levels remain well below the current price. More specifically, the 200-day moving average for the S&P 500 is still 7% lower, while its 15% lower for the NASDAQ.”