A market correction is defined as a drop in stock prices of 10% or more from their most recent peaks. If prices drop 20% or more then it is referred to as a bear market. Corrections cause a lot of anxiety, but it is important to remember that they are both normal and healthy for the stock market.
Financial markets have historically seen a significant pullback at some point during most years while still delivering positive returns over the full year. For example, in 2018, the S&P 500 saw a market correction of more than 10% in the first quarter of the year and again in the fourth quarter, followed by a rebound of more than 13% in the first quarter of 2019.
These types of occurrences are more common than you might think. Since 1920 the S&P 500 has seen 54 corrections, or once every 1.8 years. On top of that, the rebounds typically happen very close to the bottoms. Since 1974, the S&P 500 has risen an average of more than 8% one month after a market correction bottom and more than 24% one year later.
To illustrate the volatile nature of the stock market the above chart shows intra year declines vs annual returns. The grey bars denote annual returns, and the red dots show the largest intra year decline. Most recently, in 2020 the market bottomed out at 34% off the high only to rebound and finish the year up 16%.
How can you prepare for a pullback?
Do you know who historically has had the most success in dealing with stock market corrections? Long-term investors. Having a long-term view will help prevent you from making critical errors when things get choppy.
Yes, seeing your portfolio fall 30%+ in the span of a few months hurts….a lot. But, that is only short-term pain in the eyes of a long-term investor. Those who remained disciplined during last year’s pullback were rewarded with a rebound of nearly 50%. Missing any part of that rebound could cripple you financially.
We do not have a crystal ball. We cannot tell you when the next correction is just like we cannot tell you who wins the World Series this year, but we can say with confidence that there will be more corrections, and somebody will win the World Series (maybe the Phillies….but probably not).
If you would like to review your portfolio and investment objective give us a call at 610-825-3540.