The past two months have certainly been something of a wake-up call for investors who'd forgotten that the stock market actually moves in both directions.
Surprise! The stock market goes down, too
Following a year where the broad-based S&P 500 (SNPINDEX:^GSPC) practically tripled its historic average annual return of 7%, inclusive of dividend reinvestment and when adjusted for inflation, stocks have hit a speed bump in 2018. In early February, the iconic Dow Jones Industrial Average (DJINDICES:^DJI) logged three of its eight-largest single-day point declines in history, going back almost 122 years -- 1,175 points, 1,033 points, and 666 points. To boot, the Dow has also recorded three of its biggest single-day point gains since Feb. 6.
February also bore witness to the Dow and S&P 500 entering correction territory -- i.e., a decline of at least 10% from recent highs -- for the first time since early 2016. Considering how quickly these indexes plummeted from their peak to trough (just 13 days), it got quite a few investors nervous and thinking about the plunge experienced during the Great Recession.
But the fact is that most stock market corrections are nothing more than benign short-term events that give investors a great opportunity to snag high-quality stocks at a bargain price. How do we know this? Look no further than data aggregated by Yardeni Research (link opens a PDF) on the S&P 500 over the long run.
What does a stock market correction really look like?
Over the past 31 years, the S&P 500 has undergone 23 "corrections," which Yardeni Research has identified as a decline of 5% or more (although the firm points out that the standard definition of a correction is 10% or more). Of these corrections, three turned into bear markets, where the S&P 500 lost 20% or more of its value. Meanwhile, the other 20 equated to losses ranging from 5.8% to 19.9%. That works out to an average correction (i.e., all 23) every 16.2 months. Again, the stock market doesn't necessarily adhere to averages, but it also demonstrates just how common downdrafts in the stock market have been over the years.
What's more interesting than just the sheer number of corrections is how long they tend to last. The three bear markets, which resulted in respective declines of 33.5%, 49.1%, and 56.8%, took 101 days, 929 days, and 517 days to go from peak to trough. That's an average 515.7 days, or nearing a year and a half per bear market.
Comparably, the 20 other corrections ranging from 5.8% to 19.9% averaged just 66.9 days over the past 31 years. Just three of these 20 smaller corrections took longer than 100 days to go from peak to trough. In fact, every correction in the S&P 500 since 2011 has found its bottom in 100 days or fewer. The February correction that saw the S&P 500 lose 10.2% in 13 days is the shortest correction in the S&P 500's history. In essence, the stock market has endured a bear market about once a decade but has otherwise dealt with nothing more than a two-month hiccup from time to time over the past 31 years.
Another way to look at this data is that a combined 2,885 days have been spent in some sort of peak-to-trough correction on a trailing 31-year basis. Meanwhile, a considerably more impressive 8,438 days have been spent in rally mode over that same time frame.
Two things you absolutely should do during a stock market correction
So, what should you do when a correction strikes?
First, don't panic. Chances are that your original investment theses for the stocks you own still holds true, even if they've followed the stock market lower. Though anytime is a good time to review why you bought the stocks you own and ensure that thesis still holds water, a correction is an even more in-your-face reminder to do so. Only when there's been a material change in the business and/or your investment thesis does it make sense to sell a stock.
Second, don't be afraid to put your money to work in high-quality stocks. Remember, with the exception of the most recent correction, bull markets have erased each and every correction and bear market in the Dow and S&P 500 since their inception. Great businesses tend to increase in value over time, which is a great incentive to buy and hang on over the long run.