Hey Alexa – What is a Market Correction?
Behavioral Finance | Blog | Economy | Planning Perspectives | Portfolio Management
It’s official. As of earlier this week, all three major indexes (Dow Jones, S&P 500 and Nasdaq) all ended in correction territory. What is a correction? A correction is when the stock market experiences a 10% drop from it’s highs. Is it notable? Yes. Should it be worrisome? No. Let me explain.
Over the last 50 years, the S&P 500 has entered into a correction 29 times. That is a correction more than every other year. Of these corrections, 21 of them lasted less than 4 months. However, sometimes a correction can be followed by a much longer stock market slump or even a bear market or a recession.
A bear market is when the the market experiences a 20% drop from its highs and there have been about 6 bear markets in the last 50 years. A US-based recession is when the US economy experiences at least two consecutive quarters of negative economic growth. Economic growth is usually measured by GDP (gross domestic product). So, if the US economy experiences two quarters of negative GDP growth, technically that is recession territory. Over the last 50 years, we’ve experienced about 7 recessions.
As you look back over time, you realize corrections, recessions and bear markets are a common part of how our economy functions. We move in cycles, the economy expands and contracts. The market attempts to anticipate this expansion and contraction and the result can range from long bull markets, to corrections/bear markets or something in the middle.
As investors, we must be comfortable with the inevitable volatility that comes from market forces. More often then not, investors are tempted to “make a call” or decision on whether the market is about to experience a sell-off. However, many investors will neglect to think about the second decision, which is, when is the right time to get back in the market? In other words, they must also then know when the market will recover or rally.
This is a trap. If you know when the market is peaking and you know when the market is bottoming out, you have all the answers my friend. In reality, we may feel good about one side of the equation (a market peak or trough), but feeling good about both sides is extremely hard, if not impossible. To take this one step further, “feeling good” is different then “being right”.
What we know over time, is that the capital markets are a relatively efficient way of allocating capital. If you contribute capital (invest) you can benefit from the long-term growth of that capital. The price? You have to stay invested and ride out the volatility if you want to get its maximum benefits. The more growth you want to experience in your portfolio, the more exposure to equity you must maintain and the more volatility you must endure. You must allow for volatility. You must allow for corrections, recessions and bear markets.
Our goal for clients is to ensure we invest in a way that helps them meet their long-term objectives. That means we will go through both good and hard times. Sometimes, the market will work against us but more often than not, it tends to work for us. It’s when we get in our own way by attempting to time the market that we trip up and miss out on the benefits of being a long-term investor.