Market Corrections - A Historical PerspectiveSubmitted by Breakwater Financial, LLC on December 20th, 2018
As I'm sure you've noticed by now, this has not been a great year for stock and bond markets. Most stock markets are now in what is technically defined as a correction. With all the volatility, negative news stories, and predictions of doom, I thought it would be helpful to look back over the history of market corrections to put this one into perspective.
When markets are going down, the losses fall into three categories: pullbacks, corrections, and bear markets. Generally a pullback is a loss between 5% - 9.9%, a correction is a loss between 10% - 19.9%, and a bear market is a loss of greater than 20%. The starting point to measure these losses is the most recent high for the market.
According to a recent study by Guggenheim, there have been 78 pullbacks, 27 corrections, and 11 bear markets since 12/31/1945 (around the end of WWII). The average declines of pullbacks and corrections were 6% and 13%, respectively. Of the 11 bear markets, eight lost between 20% - 40% (a 27% loss on average) and three suffered losses over 40%. Pullbacks and corrections generally recover quickly, while bear markets take longer.
My point in highlighting these numbers is that, based on history, we are more likely to be in a correction than headed for a bear market. And even if we are headed into a bear market, it's most likely not going to be as bad as many fear. But why are so many fearing the worst?
As humans, we fall prey to a cognitive shortcut called recency bias. That is, we tend to remember best what happened most recently, and project those recent memories onto events occurring now and in the future. When we do this, we are not using the best information available. We are instead using the information that's easiest and quickest to recall. When we look at today's market, many are instantly assuming that we are going to go through another dot.com era bear market, or a financial crisis era bear market. Both of these bear markets fell into the over 40% decline category. However, when we look at all of the information, and not just the most recent, we know that declines of that magnitude are rare and not the norm. Additionally, we must acknowledge how remarkable it was to have two back-to-back, 40% plus bear markets because that hasn't happened before, even when we go back to the 1920's.
Another historical fact to keep in mind is that the worst bear markets were driven by recessions. There is little evidence today that our economy is headed into recession. In fact, our economic growth is greater now than it has been at any point since the financial crisis ended and the recovery began. We are also at full employment with rising wages and inflation is in check. A major reason why markets are contracting right now is because economists believe global growth will slow in 2019 and beyond. I agree that growth will most likely slow. But lower economic growth is not a recession. A recession is a contraction in economic growth. Or, in other words, negative economic growth. Few see negative growth on the horizon and slower economic growth is okay. It's a natural part of the economic cycle.
My last point is that every market downturn in the past has always recovered its losses and moved higher than where it was before the dip started. Recoveries usually happen as quickly as the downturn did and can occur over a matter of days, not weeks. Consider, for example, that in 2008 the S&P 500 gained 11.58% in one day. This is a major reason why we must stay invested in times like this and not try to time the recovery.
As always, I am available to discuss the markets ups and downs with you and how they may impact your financial plans. Until then, hang in there and know that this too shall pass.
Breakwater Financial, LLC is a registered investment advisor. The content of this blog post is for informational and educational purposes only and is not to be considered investment advice. If you have any questions regarding this Blog Post, please contact us.