5 Things to Know About Stock Market Corrections
By: Sean Williams
All three of the major U.S. stock indexes were in correction territory in early February (if rounded to the closest whole number). Traditionally, a stock market correction is defined as a drop from a recent high of 10%, or more.
After hitting their all-time highs, the Dow Jones Industrial Average (DJINDICES: ^DJI), Nasdaq Composite (NASDAQINDEX: ^IXIC), and broad-based S&P 500 (SNPINDEX: ^GSPC) all fell 10% or more. The bulk of these losses occurred over just a few days.
What riled the markets? Part of the problem is the expectation that the U.S. economy is heating up. Preliminary forecasts from the Atlanta Federal Reserve suggest that the U.S. economy could grow by 5.4% during the first quarter. Such strong growth could push inflation figures higher and coerce the Federal Reserve to get more aggressive with hiking lending rates.
We've also been witnessing a move higher in Treasury yields. As T-bond yields increase in value, the lure becomes greater for investors to move out of volatile stocks and into bonds for a safer, near-guaranteed return.
The blame can also rest with subpar operating results or guidance from major companies in the latest earnings season.
What you need to know about stock market corrections
Though the speed by which the major indexes fell in February might have ruffled investors' feathers, there are a few things you should know about stock market corrections.
1. They're more common than you realize
The first thing you'll want to know is that stock market corrections happen quite often. Including the latest correction, the S&P 500 has undergone 36 corrections of 10% or more, when rounded to the nearest whole number, since 1950. That's pretty much one every two years. Though the stock market doesn't necessarily adhere to averages, the point is that declines every now and then are both healthy and common for stocks.
2. Correction are often short-lived, relative to bull-market rallies
Another interesting tidbit is that stock market corrections are actually short-lived. Historically, moves lower in the Dow, Nasdaq, and S&P 500 tend to be swift. The S&P 500's previous 35 corrections lasted a grand total of 6,587 trading days, implying an average decline of fewer than 200 days per correction. By comparison, the S&P 500 has been in a bull market for more than 18,000 days since 1950. In other words, the stock market tends to trend higher far more often than it's declining.
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3. Everything is relative -- no two corrections are the same
It's also important for investors to recognize that no two stock market corrections are the same, and everything is relative.
For example, the magnitude of the recent point decline for the Dow had investors on edge. Seeing the words "historic plunge" in headlines was enough to poke at the nerves of any investor. However, those "historic plunges" in the Dow only erased a combined 10% in value, returning the index back to its Nov. 2017 levels, hardly putting a dent in long-term investors' profits. On a percentage basis, neither of the Dow's 1,000-plus-point drops were anywhere close to its 20-worst single-day percentage declines of all time.
4. It's a great time to review your holdings
Fourth, stock market corrections provide the perfect opportunity for investors to review their investment portfolios -- albeit anytime is a good time to do so. If your investment thesis -- i.e., the reason(s) you bought into a business in the first place -- is still intact following a 10% decline in all three major indexes, then there's no reason to panic and sell stock.
5. You'll probably regret not buying stock during a correction
Finally, don't be afraid to pull the trigger and buy more stock during a correction. Since 1950, bull-market rallies in the S&P 500 have completely erased all 35 stock market corrections, often within a matter of weeks or months. While there are no guarantees in the stock market, buying index funds during a correction is about as close as you'll get to one.
It's also a great time to consider buying dividend-paying stocks. Dividend stocks are often profitable and have time-tested business models, making them the perfect choice to help hedge your downside and build wealth through reinvestment.
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