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Indices hit pre-election turbulence

Stock markets remain weak, with sharp losses yesterday for many indices. But this is unlikely to be the start of something much bigger, and is more likely part of the normal seasonal weakness seen at this time of year.

Indices enter traditionally weak period

The period from the second half of September until the end of October is one of the weakest for stock markets in any year. On average, indices tend to struggle from the middle of September, losing ground gained in the early part of the month. October is also a mixed month; in ordinary years the US 500 tends to weaken as the month gets underway, before recovering in the second half. In US election years it is a different story, and the weakness tends to continue until election day itself.

This year markets had enjoyed a strong summer period, particularly in the US. The US 500 and Nasdaq both soared, reaching new record highs and marking the swiftest rebound in history. So in one sense some profit-taking ahead of the election was to be expected.

Tech stocks still well off recent highs

For the Nasdaq, the speed and scope of the pullback caught many by surprise. But it is important to remember that big gains such as we saw from April to September, have to be paid for, and the market volatility witnessed since the beginning of this month is the necessary correction for a rally that had become very overextended and was ripe for a pullback. The looming US election also provided an excuse for some selling, as investors reduced risk ahead of a key event, remembering the volatility that surrounded the election of Donald Trump four years ago.

It is true however that there are other concerns. As the summer draws to a close, the number of coronavirus cases is on the rise once more across Europe. In the UK there is renewed talk of lockdowns similar to those seen earlier in the year. For US investors, the outlook is darkening – they know that the US response has been patchy, with states facing repeated flare-ups of virus cases. If the US follows Europe with a broader rise in cases, then we may see a broader risk-off mood develop.

Echoes of previous market drop

The current market selloff, coming at a time when virus cases are rising, will inevitably bring back memories of February and March. But another huge drop like this is unlikely. Then investors were dealing with an entirely new concept, that of a global pandemic and lockdowns. Now they are at least familiar with the playbook of responses to control the virus. In addition, work on a vaccine is underway across the globe, and while it may not bear fruit this year, it appears to be making sufficient progress for a 2021 release.

Market crashes such as February and March do not usually happen due to something everyone can see coming. They occur because of something novel and unexpected. If another huge drop does occur, it will be from an unforeseen development. At present we are still enduring a normal correction, similar in magnitude to those seen at least once a year. Bears should be cautious – they may have a few weeks in which to play, but the overall outlook still seems to suggest a recovery will develop in due course.

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