Investors can quickly become panicked when they see the stock market experiencing a market correction, or even more daunting, entering bear market territory. The market recently experienced a correction, but these events are more common than one may think. Although the past is no guarantee of the future, over the last century, the market has recovered from drawdowns and provided higher gains for long-term investors. Market corrections are inevitable, and they are bound to happen multiple times during every investor’s life. It is easy to become negatively influenced and anxious during times of market turmoil, but rather than acting out of fear, learning the facts about similar events will provide you with a more encouraging mindset. Experienced investors are more likely to be well-informed on volatility and past market behaviors, so they are able to stay committed to their investment strategy. Having this beneficial knowledge will allow you to look past the discomfort more easily to avoid the urge to respond in a costly manner that you may later regret.
A major stock index, such as the S&P 500 or the DJIA, experiences a market correction when it falls more than 10%, but less than 20%, from a recent peak. When the decline exceeds 20%, the index enters bear market territory, which involves a higher degree of detrimental impact compared to a market correction. Market corrections are generally caused by current factors that disrupt the markets; these factors are typically temporary and quickly fade. On the contrary, bear markets are more likely to be the result of substantial imbalances that have built up over the years. These may coincide with recessions, defined as at least two consecutive quarters of decline in Gross Domestic Product (GDP), which is a measure of general economic health. Fortunately, bull markets generally last longer than bear markets and corrections. The average bull market lasts 8.9 years, whereas the average bear market lasts 1.4 years. Market corrections can be viewed as short-lived market setbacks that occur over a few months, and they are called “corrections” because the markets historically “correct” themselves where prices return to their longer-term trend. Market corrections are undeniably going to continue and affect most investors’ lives at some point. Many may find this frightening, but actually in a lot of cases, market corrections have acted as a healthy reset for investor expectations and stock valuations.
Overall, predicting stock market behavior is beyond difficult, and if incorrect, an investor may experience tremendous opportunity cost. Educated investors know that time in the market beats trying to time the market. To corroborate this point, a research study1 from J.P. Morgan found that “investors who missed the top 10 trading days during a recent 20-year stretch would have seen their returns fall by almost half, compared to those who stayed invested the whole time.” It is accurate to conclude that market corrections may damage short-term investors, but for long-term investors, they often provide buying opportunities. Times as this cause discomfort, but it is normal. Investors have to “pay to play”, and sometimes that means going through short-term discomfort to experience long-term success.
Financial markets kicked off 2022 with turmoil, where the economy is encountering a rise in geopolitical tensions, a four-decade high inflation rate, COVID-19 impacts, and interest rate hikes from the Fed – to name a few headwinds. The last factor is critical. The majority of market corrections happen during rate hiking cycles. Of course, the dynamic between the Fed Funds rate, economy, and stock market is complicated and may be different across cycles. So far this year, all three major stock market indexes, the S&P 500, the Dow Jones Industrial Average, and the tech-heavy NASDAQ, suffered corrections with the latter entering bear-market territory. However, the discomfort of market underperformance today may be softened for the average investor due to a tight labor market and strong consumer balance sheets. Additionally, market performance is ultimately driven by fundamentals such as corporate revenue and earnings. For 2022, investors will continue to stay up to date on a variety of risk factors including the Fed monetary policy, consumer spending, COVID-19, and the Russia-Ukraine crisis, but the most alarming of all is the persistently high inflation rate. Although markets do move faster than they have in the past, we can analyze past market corrections to get a better understanding of how the market may behave in the future.
Since 1950, there have been approximately 39 market corrections.2 The stock market does not follow the pattern of averages, but to put it in perspective, that is equivalent to a double-digit decline occurring in the S&P about every 1.85 years. On average, a stock market correction will take 6 months to reach its trough. 7 of those corrections took more than a year to reach its bottom, and 24 of them took approximately 3.5 months. Additionally, 6 of these 39 corrections occurred in the 2010’s. However, over the 2010 decade, the S&P 500 received a total return of about 256%; this alone proves how the market rebounded and rewarded investors who stuck it out with outstanding gains. Another example is 2018, when the S&P 500 plummeted more than 10% in the first and fourth quarter. This was abruptly followed by a rebound of over 13% in the first quarter of 2019. In the bear market between 2007 and 2009, the S&P 500 declined over 48%. On a brighter note, the S&P 500 was up 68.6% from the low point one year later and up a total of 95.4% 2 years later. Market corrections are actually extremely common. When looking at 2002 through 2021, there has been a decline of more than 10% in 10 of those 20 years – or 50% of the time. In 2 other years in that timeline, the decline was very close to 10%. Even though the markets experienced these deep falls from 2002 to 2021, they rose and provided positive returns in all but 3 years. A report from Crestmont Research3 looked into the years of 1919 to 2021 to analyze the rolling 20-year average annual total returns. The results are optimistic, as it was found that the “S&P 500 always made money for investors on a total-return basis if they held for at least 20 years”. Out of all these years, only 2 of them ended with an average annual total return of less than 5%, and more than 40 of those years ended between 10.8% and 17.1%. Furthermore, we can examine how the market tends to perform after exiting the market correction. Using data beginning in 1928, the S&P 500 had an average gain of nearly 14% one year after a market correction. One of the quickest and deepest corrections was during COVID-19, but this was also one of the speediest recoveries. In the span of a few weeks, the S&P 500 lost 30%, but it then regained all of that loss within 5 months. Within one year following the bottom of this correction, the value of the S&P 500 doubled. This example, as well as all the others, prove that market corrections are common, and that investors should avoid attempting to “fix” the correction. As mentioned, panic moves will lock in your losses and you will lose out on the future gains from recovery. Investors can benefit from understanding these historical tendencies. The market has volatility and times such as this are normal, so it is important for long-term investors to remain confident in their investment strategy.
1 Azzarello, Samantha and Roy, Katherine. “Impact of being out of the market.” J.P. Morgan Asset Management, 5 June 2020.
2 Williams, Sean. “How Long Do Stock Market Corrections Last?” The Motley Fool, 20 March 2022.
3 “Returns Over 20-Year Periods Vary Significantly; Affected by the Starting P/E Ratio.” Crestmont Research. 2022.
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