The curse of October strikes yet again. Historically known as one of the rougher months for investing in the stock market, October has made its presence felt over the past couple of days, with the piece de resistance being the perceived train wreck for all three major indexes during Wednesday's trading session.
When the gavel struck at 4 p.m. EDT on Oct. 10, the iconic Dow Jones Industrial Average (^DJI 0.56%) had fallen by 831.83 points, which represented the third-largest single-day point decline in its 122-year history. The broader-based S&P 500 (^GSPC -0.88%) shed 94.66 points, which chimes in as its fourth-largest single-session point decline of all time. Finally, the tech-centric Nasdaq Composite (^IXIC -2.05%) tumbled 315.97 points, which matches the Dow for the third-largest point decline in its storied history.
Not surprisingly, the words "plunge," "tumble", and "bloodbath" were tossed around pretty freely by investors and the media following yesterday's volatile, and deeply red, trading session. But, truth be told, there are some finer points that investors need to understand about yesterday's sell-off.
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1. Corrections are a healthy and regular part of the investing cycle
To begin with, investors shouldn't be surprised that the stock market can head lower. Since 1950, according to data from market analytics firm Yardeni Research, the S&P 500 has dropped by at least 10% on 36 separate occasions. This works out to about once every two years. Although the market doesn't exactly adhere to averages, it's a pretty clear indication that it's not going to continue going up in a straight line.
2. Stock market corrections are historically violent but short-lasting
In addition to stock market corrections being surprisingly common, they also tend to move with more swiftness to the downside in comparison to a bull market moving to the upside. In other words, corrections tend to be violent in the speed with which they achieve double-digit percentage declines.
But before you freak out, understand that these declines are usually very short-lived. Of the 36 S&P 500 corrections since 1950, 22 of them have moved from peak to trough in 104 or fewer days. Since 1982, just two corrections have taken longer than 10 months to fully find a bottom. Thus, while red arrows might be temporarily unpleasant, they don't stick around very long, based on historical data.
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3. Yesterday's declines weren't that notable on a percentage basis
Possibly one of the toughest adjustments for investors to make over time is accounting for the long-term appreciation of the stock market relative to a short-term correction.
For example, if you simply read the headline figures that the Dow Jones, S&P 500, and Nasdaq Composite fell 831.83 points, 94.66 points, and 315.97 points, respectively, you'd think Wall Street indeed faced a bloodbath. And if this was 1987, you'd be correct.
But since the end of the Great Recession in 2009, all three indexes have at least quadrupled. These single-session point declines represent percentage drops of 3.15% for the Dow, 3.29% for the S&P 500, and 4.08% for the Nasdaq. Comparably, these respectively indexes would have needed to decline by 6.91%, 6.97%, and 6.15% just to breach their 20-largest daily percentage losses of all time. Sure, these moves lower were certainly outside of the daily norm -- but they do not constitute a "plunge" in any way.
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4. There's rarely ever a single reason why stocks correct lower
Are you looking for that single reason why the stock market is heading lower? Well, don't stress yourself, because it's rarely ever just one reason. Usually, a combination of expected and unforeseen factors work together, along with investor emotions, to push the stock market lower.
Right now, rising interest rates are creating a lot of worry. As interest rates rise, investors are incentivized to move out of riskier investments, like stocks, and into bonds, which offer a more guaranteed rate of return.
Of course, it's not just interest rates. Investors are also worried about FANG stock valuations, critical commentary made by President Trump about the Federal Reserve's monetary policy actions, the trade war between China and the U.S., and U.S. midterm elections, to name a few factors. Some of these concerns can be foreseen, but rarely, if ever, are all risks apparent.
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5. Timing a stock market downturn or upturn is virtually impossible to do over the long run
Building on the previous point, probably the worst thing you can do right now is to tuck your tail between your legs, cash out your portfolio, and run for cover. Even though statistics show that stock market corrections are common, there's absolutely no rhyme or reason as to when the market will have days like yesterday to the upside or downside.
According to a study from J.P. Morgan Asset Management of the S&P 500 between Jan. 3, 1995 and Dec. 31, 2014, investors who stayed the course for the entire 20-year period would have netted a cool 555% gain. Mind you, this gain includes both the dot-com crash and Great Recession. By comparison, investors who missed just the 10 best single-session up days over this 20-year period would have seen their gains slashed to a little over 180%. Staying on the sidelines and missing out on big up days could easily derail your ability to make money and compound your long-term gains.
Image source: Getty Images.
6. Emotions may be high, but statistical data shows long-term investors have little to fear
Last, but not least, even though fear is growing among investors, pretty much every statistical data point suggests you're smart to be a long-term investor.
For instance, despite 36 stock market corrections since 1950 in the S&P 500, each and every one of those corrections has been completely wiped out by a bull market rally. With the exception of the past couple of days, an investor could have bought into an S&P 500 tracking index at literally any time between its inception and last week and made money.
Even more compelling is the fact that the U.S. economy has spent about 86% of all months since the end of World War II in expansion mode. Although recessions are inevitable, why would investors fret about one when bull markets are statistically dominant over multiple decades?
Long story short, stay the course and don't be worried by sensationalist headlines of single-day point declines in the Dow, S&P 500, or Nasdaq Composite.
