It's easy to get scared when the stock market is falling, but stock market corrections are as natural as physics – what goes up must come down. Philip Malakoff, director of research at First Long Island Investors, says long-term investors should expect that these will happen on a somewhat regular basis.
"There are corrections and it's actually quite healthy for the market when they occur," he says. "Of course it doesn't feel good when you're going through it." Terms like stock market corrections, bear markets and crashes are often used as synonyms for stock market declines but mean different things. Understanding those differences can prevent investors from making impulsive decisions that can harm future returns, market watchers say.
Learning how to handle stock market corrections
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9 facts to know about
stock market corrections
Not every correction ends in a
Wall Street crash.
9 facts to know
Three types of declines
Sam Stovall, chief investment strategist at CFRA Research, says there are three types of stock market corrections: pullbacks, in which losses range between 5% to 10%; corrections, sell-offs of 10% to 20%; and bear markets, with losses of 20% or greater.
According to Stovall's research, from
December 1945 through September 2019 the S&P 500 had 58 pullbacks in bull markets, with an average decline of 7%. He found that there were 23 corrections and 12 bear markets, of which nine bear markets were "garden variety" drops between 20% to 40%. Three were "mega-meltdowns"
of 40% or more, including the Great Recession, he says. In his tally, Stovall says he doesn't count pullbacks in bear markets. "That's double counting," he says. Any declines between zero and 5% are just noise, he adds.
Rebounds happen quicker
in smaller declines
The number of months stocks decline in
the more common pullbacks and
corrections are about equal to the number of months it takes for the market to recover to where it was, Stovall says. Pullbacks from peak to trough declines last about a month and it takes about 1.5 months to recover to break even, he says. Corrections last about four months and completely recover in about
four months.
For garden-variety bear markets, the peak to trough decline is 11 months and the time to recover and reach break-even is 14 months. The mega-meltdowns lasted 23 months and the recovery took 58 months. "If you look at a correction, even though it takes four months to get back to break even, you're experiencing a climbing market along the way,"
he says.
On average, pullbacks happen every nine
months, Stovall says. Corrections occur
every two years on average and bear
markets every five years. Declines are most likely to happen in October as it is the most volatile month of the year. October's volatility is 30% higher than the average for all 12 months. He says one reason is that third-quarter earnings can be critical, especially if a company missed earnings forecasts earlier in the year.
A miss in third-quarter earnings for a shaky company may cause investors to change their view on the firm's outlook. Mutual fund companies' fiscal years tend to end in October and they might be selling stocks they don't want to admit that they still owned, he says. October charts can look like a checkmark, he says. "You enter October and you tend to fall sharply, then you tend to start to recover by month's end," he says.
October is the
most volatile month
Multiple reasons can
trigger corrections
Jeffrey Blanchard, director of research, Bingham, Osborn & Scarborough, says markets may pull back about 5% to 7% after minor news events, such as a string of poor earnings reports or economic data. General corrections, those in the range of 10% to 12%, occur when markets are already weaker based on minor news events and new information causes prices to set back further.
"There may be some bad news that complicates things or confirms people's view that the expected return for stocks may be negative over some period of time," he says. Bear markets may signal there is some structural change occurring, such as an economy in a recession, and it may take time for the change to reverse. "All of these things are not predictable," he says.
Debates over the last
bear market
Stovall says people are nervous now because it's been 10 years since the last bear market, as measured by where prices closed that day. Some analysts argue that declines in 2011 and 2018 should be categorized as bear markets when looking at intraday price lows rather than settlement prices. "My answer is: Does it really matter? It still hurts,"
he says.
He prefers to use closing price levels to measure declines to keep historical consistency, even though others say now is different and that day session lows should be used. He says a lot of factors regarding stock trading have changed over time. "One thing has remained constant," he says. "In every bear market since the 1800s, the human response is the same. They are going to freak out and sell at the bottom."
Corrections happen in
individual stocks and sectors
Most investors only think about stock market corrections when the broader indices like the S&P 500 or the Dow Jones Industrial Average fall, but Pat O'Hare, chief market analyst for Briefing.com, says corrections happening in all the time in different individual stocks and sectors.
He says a current example is the sell-off in many software stocks, many of which are in their own bear markets, such as Slack Technologies (WORK), down about 38% since its June IPO, versus the broader market being up slightly in that period. "There's always something happening as it relates to individual stocks and corrections," he says. "The broader market itself being in a correction doesn't happen as frequently."
Markets can correct
over time
Price-based corrections happen quickly and can be hard to stomach but markets can also correct over time to allow earnings estimates to catch up with stock prices. Those are harder to see. O'Hare says he believes the broader market is currently in the grips of a time-based correction.
Although the S&P is up 19% in 2019 and there's been little earnings growth this year, the S&P is trading near April's price and is close to levels where it was a year ago before the fourth-quarter 2018 break. He says the Fed's switch to lowering interest rates in December 2018 allowed prices to rally back "on the assumption that the Fed's pivot was going to allow for time to be a bridge to better economic and earnings growth that would justify where the market was trading."
When bear markets bottom
and bull markets begin
Bear market bottoms can only be seen in hindsight because the market has to stop falling and start to stabilize, which can take time to figure out. Some market watchers say a 20% advance off a bear market is a new bull market but Stovall disagrees. Rebounding is just the first step, he says.
Prices need to recover by 20% and stay above that level for a minimum of six months. "That's not written in stone," he says. "That's my definition of a bull market." During the Great Recession, prices rose 20% in the latter part of 2008, only to fall more than 20% in the decline through March 9, he says. Stovall doesn't call that two consecutive bear markets.
"I think it simply means that we weren't done with the first one," he says.
Prepare portfolios for the
inevitable stock market
correction
If stocks never fell, there would never be any chances to buy equities cheaper, says Tim Courtney, chief investment officer of Exencial Wealth Advisors. A break in prices allows investors to rebalance portfolios and buy favorite stocks at a discount. Courtney says people who are still working and earning income can best take advantage of Wall Street declines.
Retirees and others who live off their portfolio assets need to take other actions to ride through inevitable corrections, he says. Don't tap equity assets when they're falling. "Put enough of your portfolio aside into preservation assets, cash and high-quality bonds, things that will hold their value or appreciate when stock markets are falling," he says.
9 facts to know about
stock market correction
Not every correction ends in a
Wall Street crash.
1. Declines
Three types of declines
Sam Stovall, chief investment strategist at CFRA Research, says there are three types of stock market corrections: pullbacks, in which losses range between 5% to 10%; corrections, sell-offs of 10% to 20%; and bear markets, with losses of 20% or greater.
According to Stovall's research, from
December 1945 through September 2019 the S&P 500 had 58 pullbacks in bull markets, with an average decline of 7%. He found that there were 23 corrections and 12 bear markets, of which nine bear markets were "garden variety" drops between 20% to 40%. Three were "mega-meltdowns"
of 40% or more, including the Great Recession, he says. In his tally, Stovall says he doesn't count pullbacks in bear markets. "That's double counting," he says. Any declines between zero and 5% are just noise, he adds.
2. Rebounds
Rebounds happen quicker
in smaller declines
The number of months stocks decline in
the more common pullbacks and
corrections are about equal to the number of months it takes for the market to recover to where it was, Stovall says. Pullbacks from peak to trough declines last about a month and it takes about 1.5 months to recover to break even, he says. Corrections last about four months and completely recover in about
four months.
For garden-variety bear markets, the peak to trough decline is 11 months and the time to recover and reach break-even is 14 months. The mega-meltdowns lasted 23 months and the recovery took 58 months. "If you look at a correction, even though it takes four months to get back to break even, you're experiencing a climbing market along the way,"
he says.
3. October
October is the most
volatile month
On average, pullbacks happen every nine
months, Stovall says. Corrections occur
every two years on average and bear
markets every five years. Declines are most likely to happen in October as it is the most volatile month of the year. October's volatility is 30% higher than the average for all 12 months. He says one reason is that third-quarter earnings can be critical, especially if a company missed earnings forecasts earlier in the year.
A miss in third-quarter earnings for a shaky company may cause investors to change their view on the firm's outlook. Mutual fund companies' fiscal years tend to end in October and they might be selling stocks they don't want to admit that they still owned, he says. October charts can look like a checkmark, he says. "You enter October and you tend to fall sharply, then you tend to start to recover by month's end," he says.
4. Corrections
5. Bear
6. Sectors
Multiple reasons can
trigger corrections
Jeffrey Blanchard, director of research, Bingham, Osborn & Scarborough, says markets may pull back about 5% to 7% after minor news events, such as a string of poor earnings reports or economic data. General corrections, those in the range of 10% to 12%, occur when markets are already weaker based on minor news events and new information causes prices to set back further.
"There may be some bad news that complicates things or confirms people's view that the expected return for stocks may be negative over some period of time," he says. Bear markets may signal there is some structural change occurring, such as an economy in a recession, and it may take time for the change to reverse. "All of these things are not predictable," he says.
Debates over the last
bear market
Stovall says people are nervous now because it's been 10 years since the last bear market, as measured by where prices closed that day. Some analysts argue that declines in 2011 and 2018 should be categorized as bear markets when looking at intraday price lows rather than settlement prices. "My answer is: Does it really matter? It still hurts,"
he says.
He prefers to use closing price levels to measure declines to keep historical consistency, even though others say now is different and that day session lows should be used. He says a lot of factors regarding stock trading have changed over time. "One thing has remained constant," he says. "In every bear market since the 1800s, the human response is the same. They are going to freak out and sell at the bottom."
Corrections happen in
individual stocks and sectors
Most investors only think about stock market corrections when the broader indices like the S&P 500 (.SPX) or the Dow Jones Industrial Average (.DJI) fall, but Pat O'Hare, chief market analyst for Briefing.com, says corrections happening in all the time in different individual stocks and sectors.
He says a current example is the sell-off in many software stocks, many of which are in their own bear markets, such as Slack Technologies (WORK), down about 38% since its June IPO, versus the broader market being up slightly in that period. "There's always something happening as it relates to individual stocks and corrections," he says. "The broader market itself being in a correction doesn't happen as frequently."
Markets can correct
over time
Price-based corrections happen quickly and can be hard to stomach but markets can also correct over time to allow earnings estimates to catch up with stock prices. Those are harder to see. O'Hare says he believes the broader market is currently in the grips of a time-based correction.
Although the S&P is up 19% in 2019 and there's been little earnings growth this year, the S&P is trading near April's price and is close to levels where it was a year ago before the fourth-quarter 2018 break. He says the Fed's switch to lowering interest rates in December 2018 allowed prices to rally back "on the assumption that the Fed's pivot was going to allow for time to be a bridge to better economic and earnings growth that would justify where the market was trading."
When bear markets bottom
and bull markets begin
Bear market bottoms can only be seen in hindsight because the market has to stop falling and start to stabilize, which can take time to figure out. Some market watchers say a 20% advance off a bear market is a new bull market but Stovall disagrees. Rebounding is just the first step, he says.
Prices need to recover by 20% and stay above that level for a minimum of six months. "That's not written in stone," he says. "That's my definition of a bull market." During the Great Recession, prices rose 20% in the latter part of 2008, only to fall more than 20% in the decline through March 9, he says. Stovall doesn't call that two consecutive bear markets.
"I think it simply means that we weren't done with the first one," he says.
Prepare portfolios for the
inevitable stock market
correction
If stocks never fell, there would never be any chances to buy equities cheaper, says Tim Courtney, chief investment officer of Exencial Wealth Advisors. A break in prices allows investors to rebalance portfolios and buy favorite stocks at a discount. Courtney says people who are still working and earning income can best take advantage of Wall Street declines.
Retirees and others who live off their portfolio assets need to take other actions to ride through inevitable corrections, he says. Don't tap equity assets when they're falling. "Put enough of your portfolio aside into preservation assets, cash and high-quality bonds, things that will hold their value or appreciate when stock markets are falling," he says.
7. Markets
8. Bottom
9. Portfolios
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