Anatomy of a Correction
What to make of the downturn in the market?
Market corrections are a natural part of investing, but such downturns can unnerve investors because they fear the sell-off could signal something bigger — the beginning of a longer, deeper bear market. So, what distinguishes a market correction from a bear market?
A stock market correction occurs when the market falls 10% from its 52-week high, usually to adjust for overvaluation.
Corrections temporarily stop an upward trend.
There have been 26 corrections of 10% or more (not including bear markets) in the S&P 5001.
Including bear markets, the S&P 500 has experienced a decline of 10% or more on 36 occasions, or about once every two years.
On five additional occasions the S&P 500 declined more than 9% (9.9% in 2012, 9.8% in 2011, 9.8% in 1956, 9.6% in 1965, and 9.4% in 2007).
On average, market corrections have lasted 4.3 months, within a range of 18 to 531 days.
The average correction has resulted in a drawdown of 14.1%, and they have ranged between -10.1% and -19.9%.
The average recovery period from a market correction is about 3.3 months.
A bear market is when stocks decline 20% or more.
Bear markets are characterized by a persistently downward trend, measured in months or years.
10 BEAR MARKETS
There have been 10 bear markets and 11 economic recessions since the end of 1945.
Bear markets are often associated with recessions, but they have occurred without recession, and recessions have occurred without a bear market.
On average, bear markets have lasted 21.3 months.
The S&P 500 index has declined an average of 32.4% in bear markets, and such declines have ranged between -21.6% and -56.8%.
The average recovery time from a bear market is around 27.4 months.
There is no numerically specific definition of a stock market crash, but the term commonly applies to a steep double-digit percentage loss in a very short period of time, sometimes accompanied by trading halts or other market discontinuities.
Market crashes are rare. They can sometimes be a precursor to a correction or a bear market, and they are sometimes, but by no means always, associated with economic recessions.
Market crashes can occur in a single day or over a period of several days.
The S&P 500 fell -20.5% on a single day on Black Monday (10/19/1987) in the middle of a short-lived bear market that did not involve a recession.
During the May 6, 2010 Flash Crash, the S&P 500 fell 7% intraday but ended the session down 3.2%. The Flash Crash occurred in the early days of a market correction.
In just 20 trading days between 10/14/1929 and 11/13/1929, the S&P 500 fell 42.2%; the Great Depression followed.
Recovery period is similar to that of a correction, unless the crash is a precursor of an economic recession.
1 Sources: Bloomberg and Legg Mason, as of February 5, 2018. Percentages are based on index closing prices since December 31, 1945.
Market corrections occur when investor optimism pushes prices too far ahead of underlying fundamentals, leading to profit taking, which can in turn stoke broader panic-selling that pushes prices even lower. Bear markets are different, and most often reflect the onset of recession, as deterioration in the corporate earnings outlook and macro economy begins to put downward pressure on stock prices before the official start of a recession.
Market corrections can be healthy for both the market and for investors, allowing an opportunity to consolidate recent gains and prevent a more serious situation of overvaluation from developing before going toward higher highs.
A correction can be an opportunity for value investors to pick up good companies at bargain prices, and it can also signal a change in future market leadership. In addition, corrections provide a chance for investors to reassess how comfortable they are with market risk, and to make adjustments to their portfolio, if warranted.
What not to do
Don’t panic. Don’t let temporary market conditions derail your long-term investment plan. Panicking can lead to decisions that result in unnecessary losses, which can impede long-term potential.
What to do
Consult your financial advisor, examine your portfolio diversification and learn more about active managers with experience navigating various market cycles.
All investments involve risk, including loss of principal. Past performance is no guarantee of future results. Please see each product’s webpage for specific details regarding investment objective, risks associated with hedge funds, alternative investments and other risks, performance and other important information. Review this information carefully before you make any investment decision.
Diversification does not guarantee a profit or protect against loss.
Active management does not ensure gains or protect against market declines.
Forecasts are inherently limited and should not be relied upon as indicators of actual or future performance.