A quick look at a timely topic of interest – with a brief review of why it could matter to investors.

Chart of the Week

August 31, 2015

Market correction: welcome back
S&P 500 closing price, bear markets & 9%+ corrections

chart

Source: Bloomberg, as of 8/25/15. Past performance is no guarantee of future results. Indexes are unmanaged, and not available for direct investment. Index returns do not include fees or sales charges. This information is provided for illustrative purposes only and does not reflect the performance of an actual investment.

The bottom line:

  • They say absence makes the heart grow fonder, but that's not the case when it comes to stock market corrections.
  • But while unloved, corrections are part of equity investing and arguably healthy—since they prompt a careful assessment of current valuations.
  • And the lack of a significant pullback for over three years may be one reason so many investors were dismayed by last week's market turmoil.
  • As shown above, corrections¹ and bear markets are hardly unusual. There have been 25 corrections (red columns) and 12 bear markets (gray columns) in the past 60 years.
  • That means, on average, that the S&P 500 has experienced a drop of 9% or more about every 19 months.
  • The average correction since 1955 resulted in a price drop of about 11.9% and lasted 57 days—ranging in decline from 9% to 19.4% and in longevity from 13 to 147 days.
  • So far, this most recent pullback has resulted in a 12.35% drop over 67 days—from an all-time closing high of 2130.82 reached on May 21, 2015 through the close on August 25, 2015.
  • Although the S&P 500 peaked three months ago, it had traded only marginally lower—and in a sideways pattern—until dropping over 11% in just six trading days (8/17-8/25), catapulting anxiety to heightened levels.
  • Yet that's sometimes how corrections come to an end. Consider the sell-off associated with the Asian currency crisis of 1997; it witnessed a 6.87% drop on its last day, October 27, 1997.
  • Indeed, big selloffs in a short period of time can be a sign of capitulation, which can lead to the formation of a market bottom that sets the stage for the next leg up.
  • Whether that proves to be the case remains to be seen, but one could easily argue that the markets were overdue—especially since stock prices had grown much faster than earnings in recent quarters.

The chart:

  • The chart shows the closing price of the S&P 500 (blue line) on a logarithmic scale from August 31, 1955 through August 25, 2015.
  • It also shows corrections (red columns) and bear markets (gray columns)—both defined in footnote 1 below—that occurred over those 60 years.

 

¹ A correction is commonly defined as drop in price of 10% or more and a bear market as a drop of 20% or more. For our purposes, we have defined a correction as a drop in price of 9%-20% and stick with the common bear market definition as a drop in price over 20%. We chose 9% instead of the "official" 10% to define a correction because in some cases intra-day trading could have easily resulted in a 10% drop that is not reflected in closing price, which we use in the chart—and when you really get down to it, there's little difference in a 9.8% and a 10% drop.


Definitions:

The S&P 500 Index is an unmanaged index of 500 stocks that is generally representative of the performance of larger companies in the U.S.


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