What is a Stock Market CORRECTION?

By Staff Reporters

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A correction is a decline of 10 percent or more from an asset’s most recent high. For a stock that recently reached an all-time high of $100 per share, a correction would occur if the stock fell to $90 or lower. Corrections can happen in any financial asset such as individual stocks, broad market indexes like the S&P 500 or commodities. The S&P 500 fell below 4,336 in January 2022, marking a more than 10 percent decline from its high earlier in the year.

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Corrections can be caused by a number of different factors and they’re difficult, if not impossible, to predict ahead of time. Short-term concerns about economic growth, Federal Reserve policy, political issues or even a new variant of the COVID-19 virus all have the potential to trigger market corrections. These issues make investors fearful that their prior assumptions about the future might not be correct. When people are fearful, they typically look to sell stocks in favor of assets considered safer such as U.S. Treasury bonds.

CITE: https://www.r2library.com/Resource/Title/082610254

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Difference between a correction and a crash

A stock-market correction may sound similar to a crash, but there are some key distinctions between the two. A crash is a sharp drop in share prices, typically a double-digit percentage decline, over the course of just a few days. A correction tends to happen at a slower pace, therefore making the drop less steep than a crash would be. One of the most famous stock-market crashes happened in October 1987, when the Dow Jones Industrial Average fell 22.6 percent in a single day that became historically known as Black Monday.

Corrections are more subtle and are sometimes even thought to be healthy for rising markets because they help things from becoming overheated. Like their name suggests, they correct prices back down from a slightly elevated level.

Difference between a correction and a bear market

The difference between a correction and a bear market is in the magnitude of the decline. A correction is a decline of at least 10 percent, but less than 20 percent, while a bear market begins at a decline of at least 20 percent from a recent peak. Bear markets also tend to last longer than corrections because they tend to reflect an economic reality, such as a recession, rather than a short-term concern that may or may not materialize. The challenge for investors is that it’s very difficult to determine in real time whether a market is just in a correction or if it could become a bear market.

Related: https://medicalexecutivepost.com/2022/05/16/update-stock-market-sentiment-and-capitulation/

MORE: https://www.merrilledge.com/article/how-weather-stock-market-correction

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On The Next Stock Market Correction?

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Remember the Ace Up Your Sleeve!

By Lon Jefferies MBA CFP® CMP®

Lon JeffriesAfter the historic growth the stock market has experienced since early 2009, many physician investors have felt that a healthy pullback may not be a completely negative thing.

After all, we certainly don’t want another bubble, or stock prices that are clearly out of line with the earning potential of the underlying companies.

Unfortunately, market corrections never feel healthy when they occur. Physicians, investors and almost all people get uncomfortable when the market declines, the media fans the flames by giving investors reason after reason to be afraid, and worries that this is the beginning of the next crash begin to develop.

While many investors admit that a 5% pullback is manageably unpleasant, concerns expand when the market decline hits 10% — right when the media can officially throw around the word “correction.”

Of course, we have no idea when the next drop will occur, but why not mentally prepare ourselves by exploring what has traditionally happened to stock prices once that 10% decline is crossed?

The Data

Ben Carlson, an institutional investment portfolio manager, looked at the S&P data going back to 1950, and found that there have been 28 instances when stocks fell by 10% or more. Thus, on average, the market has entered an official correction every 2.25 years. The last market correction occurred in 2011, so another 10% drop at this time would correlate pretty close to the average amount of time between corrections.

Obviously, the market has done pretty well since that last temporary correction in 2011. Clearly, such a drop is quite normal and far from historically concerning.

  • S&P 500 Losses of 10% or More Since 1950
  • Total Occurrences: 28 Times
  • Average Loss: -21.6%
  • Median Loss: -16.5%
  • Average Length: 7.8 Months
  • Greater Than 20% Loss: 9 Times
  • Greater Than 30% Loss: 5 Times

Your Advantage

Are you thinking “I don’t think I can stomach that median loss of 16.5%?” Then it’s time to pull out the ace up your sleeve. Remember that the data above represents the historical performance of the S&P 500 – an index that is composed of 100% stocks. A capable financial planner would ensure you have an asset allocation mix between stocks, bonds, and cash that represents your tolerance for risk.

Consequently, your portfolio likely isn’t 100% stocks. In fact, the appropriate allocation for an average investor approaching or already enjoying retirement might be closer to only 50% stocks. This means that on average, your portfolio should decline only half as much as the S&P 500 during market downturns.

This ace may bring the loss endured by our sample investor with a 50% stock portfolio down to around 8.25% during the median decline. Are you now back in the “manageably unpleasant” range? If so, you likely have an appropriately constructed portfolio. If not, your risk tolerance may need to be reevaluated to ensure you are not exposing your nest egg to a larger loss than you can endure.

Avoid Harmful Reactions to the Market

Although the recent market pullback produces what seems like a foreign feeling, we’ve been here before. The S&P 500 declined in value by 18.64% over a 5 month period in 2011. However, an investor with a 50% stock portfolio likely only saw their account values drop around 9%-10% — still not fun, but manageable.

Assessment

Of course, we don’t know whether the market will continue to bounce back or again drop into official correction territory. If you continue to hear about the broad markets declining, remember that the average historical correction has been far from catastrophic, and that you have the ace of an appropriate asset allocation up your sleeve.

Financial Planning MDs 2015

Comprehensive Financial Planning Strategies for Doctors and Advisors: Best Practices from Leading Consultants and Certified Medical Planners™

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