On the heels of the worst daily performance since Nov. 7, stocks rebounded today, with the S&P 500 (^GSPC 0.59%) and the narrower, price-weighted Dow Jones Industrial Average (^DJI 0.82%) gaining 1.4% and 1.1%, respectively.
As the market found its nerve, the VIX Index (^VIX -2.24%), Wall Street's fear gauge, which had shot up 43% yesterday, fell back nearly 20%. (The VIX is calculated from S&P 500 option prices and reflects investor expectations for stock market volatility over the coming 30 days.)
Is a correction coming?
The poll on the front page of Yahoo! Finance today plumbed the market's psychology, asking: "Do you think a correction on stocks is on the horizon?" Here are the results as of roughly 6:25 p.m. EDT, with nearly 75,000 respondents:
- Yes, it's coming: 54%
- No, we have more room to run: 20%
- I'm not convinced either way: 26%
A majority of investors expect a correction! I think there is good reason to believe this result is heavily influenced by yesterday's 2.3% decline in the S&P 500, due to a psychological effect that goes by the name of "recency effect" or "recency bias," according to which people put a heavier weight on the most recently available data -- in this case, a sharp one-day decline in stock prices.
It would have been interesting to see the results of the same poll as of last Friday -- my guess is that the number of people expecting a correction would have been substantially lower than 50%. If you accept that hypothesis, the question then becomes whether Monday's events require a fundamental reappraisal of that risk -- I don't think they do. Either way, the table below shows the average performance of the S&P 500 over the three-month, six-month, and one-year periods following a one-day decline greater than yesterday's (of which there have been 235 occurrences since Jan. 1950):
|
63 Trading Days (~ 3 Months) |
126 Trading Days (~ 6 Months) |
252 Trading Days (~12 Months) | |
|---|---|---|---|
|
Average % Return, S&P 500 |
3.5% |
6.5% |
11.8% |
|
Bottom Quintile Cutoff |
(4.3%) |
(6%) |
(8%) |
Author's calculations, based on data from Yahoo! Finance.
I'm not expecting a correction, although, naturally, I can't rule it out. Equities are volatile and they've had a tremendous run. Even if they do correct, investors who are invested in high-quality franchises at reasonable valuations have time on their side and need not be concerned.
