Following multiple all-time closing highs for all three major indexes, the stock market issued a stern warning to investors on Friday, Jan. 24, and Monday, Jan. 27 -- namely, that it can go both up and down.
When the closing bell rang on Monday, the iconic Dow Jones Industrial Average (^DJI -0.16%), tech-heavy Nasdaq Composite (^IXIC -0.13%), and benchmark S&P 500 (^GSPC -0.38%) all shed at least 1.57%, marking their collective worst day in three months. The blame appears to lie with the rapidly spreading coronavirus from the Hubei province in China, which could contribute to weaker Chinese (and global) growth prospects or even lead to a recession. The coronavirus, which often presents with flu-like symptoms but can be deadly for people with compromised immune systems, has claimed more than 100 lives as of this writing.
Being unaccustomed to seeing moves like a 52-point drop for the S&P 500, 176-point decline for the Nasdaq, or 454-point tumble for the Dow might have some investors rightly worried. But a quick trip down memory lane when it comes to stock market sell-offs and corrections should give you the tools and confidence to succeed no matter what the stock market does on a day-to-day basis.
Here are 10 things you should know about this recent stock market sell-off.
1. Sell-offs are common
To begin with, understand that sell-offs and corrections (i.e., declines of at least 10% from a recent high) happen with more frequency than you probably realize. Over the past 70 years, the broad-based S&P 500 has undergone 37 corrections of at least 10% (not including rounding), equating to one every 1.89 years. If we take a closer look at sell-offs in, say, the 5% to 9.9% range, the frequency is even more common. In other words, don't be surprised if the stock market pulls back from time to time.
2. Sell-offs/corrections usually don't last very long
Interestingly, you might be surprised to learn that a majority of the S&P 500's 37 corrections found their bottoms rather quickly. In 23 of 37 instances, it took 104 or fewer calendar days for the stock market to go from peak to trough.
Just as intriguing, we've only had 3 of those 14 instances in which it took longer than 104 days to find a bottom since 1984. The reason? I'd surmise the rise of computers and the advent of the internet has made accessing information easier than ever for Wall Street and retail investors. This has led to more informed decision making and fewer extended stock market downturns.
3. We rarely know the cause of a market sell-off ahead of time
Predicting why the stock market will sell off is more luck than science. Rarely does Wall Street accurately predict the reason behind a drop in equities ahead of time, with some X-factor often being the cause. In our latest instance, a new form of coronavirus has investors on edge -- and I certainly didn't hear Wall Street analysts cautioning anyone about the potential for a pandemic three months ago.
4. Corrections are typically driven by investor emotions
The reason sell-offs can weigh on investors is because they're usually driven more by emotions than by logic. Just as the fear of missing out causes investors to buy into the newest hot investment trend, the fear of being caught in a downdraft can quickly send traders to the sidelines. But as you'll see a few points from now, a number of companies and/or industries should be completely unaffected by even a worsening of the coronavirus in China.
5. Only short-term traders feel the pain caused by sell-offs
Truth be told, it's only short-term traders that are going to be adversely impacted by this sell-off. Many of the most successful investors have made the bulk of their fortunes in recent years thanks to compounding. In essence, they've invested in high-quality businesses and held for long periods of time, not to be scared away by the occasional sell-off or correction. The reward of being patient far outweighs the "what if's" associated with short-term investing.
6. Running for the sidelines is often not a smart move
Though it might seem like a smart idea to pack it up and head for the sidelines at the first sign of stock market turbulence, this, too, proves to be a bad idea more often than not. According to an annual report published by J.P. Morgan Asset Management that examines the trailing 20-year performance of the S&P 500, 50% to 60% of the market's best days (i.e., it's top single-session percentage gains) are often found less than two weeks apart from its worst-performing days. Miss just a handful of these top-performing days because you headed for the sidelines and you could be kissing a huge chunk of your long-term returns goodbye.
7. It's a good reminder to reassess your holdings
Stock market sell-offs are also a solid reminder for investors to reassess their holdings. Ideally, you can do this at any point and don't have to wait for a correction, but a sudden drop in equities does tend to get the attention of investors. When assessing your holdings, simply ask yourself if your initial investment thesis for buying Stock XYZ still holds true. If it does, even if it's getting nominally clobbered during a sell-off, there's no reason to sell.
8. All sell-offs have historically been buying opportunities
Did you know that every single sell-off and stock market correction in history has proved to be a buying opportunity? As mentioned previously, the S&P 500 has undergone 37 corrections over the past 70 years, each of which was eventually put into the rearview mirror by a bull-market rally. In other words, buying high-quality companies or index funds and being patient is an almost surefire way to create wealth.
9. There are plenty of recession-resistant stocks you can buy
As noted earlier, there are always companies or industries that more risk-averse investors can buy into during sell-offs that should outperform. In general, any business that provides a basic-need good or service is well positioned to thrive in any environment. Take U.S. electric utilities like NextEra Energy (NEE -1.98%) as the perfect example. The proliferation of coronavirus in China isn't going to have one iota of impact on electricity consumption for NextEra's customers or on its renewable energy spending.
Aside from NextEra, companies like telecom giant AT&T, spice and condiment kingpin McCormick, robotic-assisted surgical system developer Intuitive Surgical, and apartment-focused real estate investment trust AvalonBay Communities aren't going to see their businesses impacted by this sell-off.
10. Dividend stocks have track records that speak volumes
Lastly, sell-offs are a great time to pick up dividend-paying stocks that have a track record of growing their payouts. According to a 2013 report from J.P. Morgan Asset Management, companies that initiated and grew their payout between 1972 and 2012 returned an average of 9.5% per year during this 40-year stretch. This compared to just a 1.6% annualized return for non-dividend-paying stocks over this same time frame. This is why NextEra Energy in the cash-flow-predictable utility space can be such a solid investment when the stock market turns south.