StonebridgeMARKETS | Market Correction: The Medicine Nobody Wants to Take
“The stock market is a device for transferring money from the impatient to the patient.”
Warren Buffett
People love to say that knowledge is power. However, the truth is that knowledge is only potential power. It is useless if you don’t act on it. Uncertainty makes many people fearful – and this prevents them from achieving their greatest potential by investing in financial markets and becoming long term owners of this economy; not just consumers. History tells us that corrections occur with surprising regularity but never last. The best investors prepare the dramatic ups and downs and turn it to their advantage. Once you understand these patterns, you can act without fear.
Earlier this week, SEI Private Trust Company published a Commentary entitled, “The S&P 500 Correction: The Medicine Nobody Wants to Take” which we thought would be of interest.
Commentary in brief:
- The S&P 500 dipped into correction territory (a 10% decline) amid concerns about interest rate hikes, inflation, and war.
- On average, a correction in the U.S. stock market occurs every year or so and takes about four months to recover from peak to trough.
- Despite the concern that corrections tend to cause, they are necessary for the health of the overall market.
This week, the S&P 500 Index fell into correction territory—that is, it declined by 10% or more from its most-recent high. The drop was triggered by a variety of factors, including the impending balance sheet reduction and eventual interest rate hikes from the Federal Reserve, persistent inflation, and the escalation of conflict between Russia and Ukraine.
The decline comes just short of the two year anniversary of the previous correction, which took place on February 27, 2020. That downturn was driven by a sharp rise in fears about COVID-19. While nobody likes to see markets fall, Exhibit 1 provides some perspective: on average, U.S. stock market corrections occur about once every year.
Exhibit 1: Corrections are common1
While it is understandable that investors may be alarmed when the market falls, it is important to recognize three important facts about stock-market corrections: they are common; they aren’t typically tied to an economic crisis; and they are necessary for the health of the overall market.
A more detailed look back provides additional perspective. As seen in the below exhibit, the average recovery period for declines of less than 30% is less than six months. That means a correction is just a temporary setback for a long-term, achievement-based investment strategy, and about half of all corrections since 1966 have resolved themselves in less than five months.
Declines in the S&P 500
Corrections don’t last forever
While stock markets have had a good run since mid-2020, we’re not surprised by the recent volatility. Although no one likes to see the value of their investments decrease, we know that markets don’t climb straight up forever.
Given the volatility that typically follows a severe selloff, it’s understandable that stock-market corrections cause consternation among investors. But still, why would the word “correction” be associated with something that causes investments to lose value? The simple answer: A decline corrects market exuberance that may otherwise result in stock prices rising faster than is justified by underlying company earnings.
What to do when the stock market corrects?
Just wait. Remember, U.S. corrections typically last about four months (peak to trough)2 and, despite their regularity, the average annual return for the S&P 500 Index over the last 50-years has been about 10.0%. Using a different lens, the S&P 500 has gained value in 40 of the past 50-years. So, there’s a good chance unrealized investment losses, as a result of a correction, will be recaptured in the long run3.
Despite the anxiety caused by the recent pullback, it is serving a crucial purpose: resetting the market’s valuation and investors’ expectations to more reasonable levels. Plus, investors with spare cash on hand can treat the lower stock prices caused by a correction as a buying opportunity. And, perhaps most importantly, if you overreact by selling investments, you could miss out on gains when the market bounces back. After all, as Merriam Webster says, a correction is just “the act of making something better.”
Our Point of View:
Instead of getting distracted by all the noise from the merchants of doom, it helps to focus on the facts that matter. For example, corrections are routine. The most significant danger to achieving your career, life and wealth goals isn’t a correction or a bear market; it’s being out of the market4. Finally, I’m reminded of the words of Sir John Templeton, one of the greatest investors of the last century who said, “The best opportunities come in times of maximum pessimism.”
If you would like to read the full Commentary, please do not hesitate to contact our team directly and request a copy. We look forward to continuing to provide useful insights and relevant solutions focused on achieving your career, life, and wealth goals.
Thank you for your continued trust and confidence in Stonebridge.
All the best,
Mitch
[1] Source: Ned Davis Research, SEI. Data spans 1/1/1926-2/22/2022. Data are computed from the S&P 500 Index since 1957 and S&P 500 Index from 1926 to 1957. Index returns are for illustrative purposes only and do not represent actual investment performance. Index returns do not reflect any management fees, transaction costs or expenses. Indexes are unmanaged and one cannot invest directly in an index. Past performance does not guarantee future results.
[2] Source: Crandall, Pierce & Company. Market Volatility, Declines & Recovery Expectations, 1945 through December 2021.
[3] This material represents an assessment of the market environment at a specific point in time and is not intended to be a forecast of future events, or a guarantee of future results. This information should not be relied upon by the reader as research or investment advice and is intended for educational purposes only.
[4]There are risks involved with investing, including possible loss of principal. Diversification may not protect against market risk.