Corrections Are Not Predictable


Posted in: Economics, General, Stock Market, Thought of the Week

The prevailing belief across most media outlets and market pundits is that a correction in equity prices is looming simply because we have not experienced one in over two years. A correction in equity prices is defined as a 10%-20% decline in the market. Oftentimes these corrections are considered to be healthy stages in a rising market because stocks often get ahead of themselves fueled on excessive investor enthusiasm. History has shown that equity markets usually see a correction once every 18 months. However, our Investment Committee strongly believes that the data does not support this notion.

Last week, our Investment Committee conducted research to dig deeper into the frequency of corrections using data from Down Jones, Morningstar, and Bloomberg. They came away with three interesting conclusions:

  1. Corrections are Not Consistent: Since the end of World War II, there have been 27 corrections of 10% or more, and only 12 bear markets (losses of 20%+). Although this does equate to about one every 20 months, they are not spaced out evenly. Nearly 50% of the corrections occurred during the last two bear market decades (1970s and 2000s).
  2. They Don’t Last Long: The average decline during these 27 time periods has been 13.3% and took an average of three months to play out.
  3. Bull Markets Are Different: From the beginning of the last secular bull market in 1982 through the 1987 crash, there was just one correction of 10% or more. Between the Crash of 1987 and the secular bull market’s peak in March 2000, there were just two corrections. In other words, secular bull markets can run for a long time without a correction.

 

Our Investment Committee believes that we are in the early innings of a new secular bull market. A secular bull market is defined as a bull market that lasts for a time period of a decade or longer. In addition, they anticipate a similar path up in equity prices over the coming years. However, since we have not seen this pattern in equity prices for close to twenty years, investors have become accustomed to seeing corrections far more frequently. There is no historical precedence to support the notion that a correction is looming right now for the sole reason that we have not experienced one in a while.

Those who believe that a correction is right around the corner have recently pointed to the spike in volatility over the past three weeks as yet another potential catalyst. As strange as it may seem, the Investment Committee actually welcomes this rise in volatility with open arms. Volatility allows long-term investors to build positions as short-term traders continue to sell. Furthermore, rising interest rates may be bad for traders that attempt to profit from short-term moves in equities, but they are great for investors because rising interest rates during periods of controlled inflation indicate that our economy continues to get stronger at a healthy pace.

In summary, our Investment Committee is not making a call that a correction will or will not happen in the coming months because there are no certainties in this business. The data our Investment Committee presents to investors is to make the point that a correction does not have to happen simply because one has not happened in a while. For now, our Investment Committee remains focused on the strengthening fundamentals in our economy and seeking investments in companies that have the potential to consistently grow their earnings.

Read this week’s Thought of the Week to learn more about the “correction” that everyone is talking about.

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As an Investment Advisory Representative working in conjunction with Global Financial Private Capital (GFPC) we are provided weekly thoughts on what is happening in the economy and the market. Written by our investment committee at GFPC we find these thoughts to be informative and interesting.