Last month saw sustained market carnage around the world as the Dow lost 10% of its value and other indices followed suit. The TSX index was no exception, falling more than 10% in the span of October. A decline of that magnitude is usually defined as a correction, although the exact meaning of that word can be imprecise, as we’ll see in a moment.
Nevertheless, one thing can be said with certainty:
Almost every investor is thinking about how to respond to this.
Is this correction a buying opportunity? Will it spill over into a recession? Are there certain types of stocks that will be safe should the losses continue?
In order to answer these questions, we first need to understand what, precisely, a correction is.
Pullback vs. correction
A correction is defined as a short-term pullback in the markets. According to Technical Analysis of Stock Trends by Robert Edwards and John Magee, a correction is a short-term decline of between 5% and 20%. Anything less than that is just a dip, anything larger or longer-lasting is a bear market. It should be noted that these authors’ definitions are not universally agreed on. However, most commentators agree that a true bear market requires losses of 20% over a prolonged period of time.
Ultimately, it’s only with hindsight that we can truly say whether we’re in a correction or a full-on bear market. One way of predicting how long a pullback will last is to look at the reasons behind it.
Reasons for the slide
There are a few reasons why the TSX is sliding, the major one is simple spillover from the U.S. markets. Historically, a major selloff in the U.S. results in the same thing happening here. As for why the U.S. markets tanked, it was probably a combination of rising interest rates and the fact that the bull market had been running for so long. The average bull market lasts nine years and the recent one had been going on for nine-and-a-half. Simple profit-taking after a long term bull run is the most likely cause.
The depth of the TSX selloff was also influenced by a steeper selloff in cannabis socks, which fell far more than the market average.
What to do
Ultimately, it’s impossible to forecast exactly how long a correction will go on for or how far prices will slide. However, there are a few things an investor can do in times like these.
If you had bought stocks or a representative index fund more than a five years ago, you could get out of the markets now with a tidy profit. The past nine years have witnessed an unprecedented bull run, and unless your holdings were extremely unrepresentative of the TSX, you should have a good return that you can cash in before buying back your shares at lower prices.
If you’re not in the markets right now, this could be an excellent time to buy. The TSX index is still down from its October highs, yet many companies’ Q3 earnings reports are not looking bad. Now might be the ideal time to buy into a stock with rock solid fundamentals like Canadian National Railway (TSX:CNR)(NYSE:CNI), which will almost certainly weather this storm and emerge better than before.
Fool contributor Andrew Button has no position in any of the stocks mentioned. David Gardner owns shares of Canadian National Railway. The Motley Fool owns shares of Canadian National Railway.