An Equity Market Correction

Equity markets likely correct 5% to 10% over the next six weeks, if for no other reasons than a bevy of Wall Street strategists seemingly agreed last week that conditions appeared ripe for such a move. No major problem, in my view: it’s been a while since equities digested their sizeable gains. Typically, corrections, providing they don’t accelerate beyond the 10% level or so, prove healthy for long-term equity price appreciation.

Corrections, as they materialize, lead me along a few lines of thinking:

1. Are the medium- to long-term economic conditions constructive for ongoing equity price appreciation?
2. What conditions could prevail that amend the correction? and
3. Might unforeseen or ill-considered phenomena drive a correction beyond the “healthy” 5% to 10% level and deeper into damaging territory?

Medium- to long-term economic conditions remain constructive for ongoing equity price appreciation, in my opinion. Abundant liquidity in combination with ultra-low interest rates and the aforementioned increases in equity prices result in corporate and personal balance sheets that rank among the healthiest in history. The resulting climate for fixed income investing from low interest rates also make equities the most attractive option from a risk-reward basis for investment capital, a relationship we expect to persist for the next 18 months or so. The dislocation of employment over the past year and a half, while terribly painful for tens of millions, results in among the most attractive backdrops for employment prospects ever.

Conditions that could win-out and perpetuate the overall trajectory for equities in 2021 without a correction include:                 

• Acceleration of a decline COVID-19 cases,
• Rising consumer sentiment from that drop in COVID-19 cases that propels increasingly positive expectations for Holiday 2021 shopping,
• Bipartisan support for a sensible Federal budget,
• A lower-than-feared increase in the corporate tax rate related to that sensible budget
• Declining logistical challenges to putting sufficient products in inventories and onto shelves for consumers to purchase during their Holiday 2021 shopping,
• Increasing employment participation related to declining COVID-19 cases and improving consumer confidence and sentiment

Any number of unexpected events or underappreciated issues could lead an equity market correction beyond a healthy level and into destructive territory. The key, in my view, is to focus on those factors with the highest probabilities of occurring. COVID-19 challenges rank chief among these factors. Increased infections, escalating hospitalizations, and mounting mortality rates – to say nothing of the possibility of an “Epsilon” variant developing in response to our ineptitude at controlling the Delta variant – that undermine fundamental economic activity could deepen a correction and turn it into an equity market tailspin. Further increases in Federal spending WITHOUT requisite increases in the amount of goods and services that consumers can purchase, would make a mess of equity values as well The heavy-handedness with which Chinese authorities chose to deal with mounting inequalities in the country and/or an implosion of Chinese property markets that spills over to international capital markets or disrupts recoveries in global semiconductor production also could exact deleterious impacts on equity markets.