Stocks Flirt with Correction Territory – Should You Be Concerned?
Equity investors cheered the first half of the year. Stocks rallied hard off the bear market bottom, even rising through regional bank failures and what many feared was another financial crisis.
But the good times came to an end on July 31.1
In the August, September, and October stretch, stocks declined rather sharply and with little respite, with the S&P 500 falling -9.9% through last Friday and the Nasdaq falling even further. Since a correction is technically defined as a sharp decline between -10% and -20%, the S&P 500 did not technically enter a correction. But it’s close enough.
This downdraft came before the S&P 500 managed to eclipse its 2021 all-time high, and it was also accompanied by a big upward move in long-duration bond yields and more recently, the breakout of war in the Middle East. Many investors are stepping back and questioning the veracity of this bull market.
I’ll touch on the interest rate and geopolitical issues more below. But the first point to make here is to remind readers that short, sharp declines in the stock market are very common. Since 1980, the average intra-year decline for the S&P 500 is -14.3%, signaling of course that downside volatility is not an anomaly—but a feature—of equity investing. During the 2009 to 2020 bull market, for instance, there were a total of nine corrections. Said another way, there were nine scary, sharp declines amid one of the strongest bull markets in history. It’s normal.
An example from history that somewhat resembles what we’re seeing today happened in March 2003, which was a correction very early on in the post-tech bubble bull market. Then, as now, investors feared the potential implications of a war in the Middle East, and perhaps other nations in the region. I don’t want to discount the possibility that the war expands into more of a regional or even global conflict, which could be bearish for markets and should be watched closely. But for now, I think the impact on the U.S. and global economy will be modest if not negligible.
On the matter of higher interest rates, I’ve written quite a bit recently about my view that stronger-than-expected economic growth is the main factor pressuring them higher. The very strong Q3 US GDP reading is evidence of this occurring.
Embedded in this view is the idea that strong growth is not ultimately a negative for markets, it’s a positive. Some investors may challenge this view by saying that stronger growth only means rates will continue to move higher, and stay higher for longer. That’s fair, but it’s also true that since 1962 – when data on 10-year constant maturity yield starts – over 50% of trading days featured rates higher than 5% (see chart below). There were bull and bear markets in this stretch, but stocks overwhelmingly rose.
The 5% 10-year Treasury bond yield seems to be a matter of focus for the media currently, as though it’s a threshold that is make-or-break for stocks. But again, as seen on the chart above, rates were above 5% (the red line) from mid-1967 almost through 1998. In that time, stocks rose over +3,000%.
The issue that often troubles many investors – and ultimately hurts them – is that they let volatility increase their temptation to “time the market,” allowing short-term uncertainties to drive their decision-making. But it’s important to remember that volatility works both ways. Rapid declines are often followed by rapid recoveries. One may be starting now.
When an investor gets caught up in the negative news stories and sells into the downside of a correction, it often means capturing the losses but failing to participate in the recovery, which is a recipe for sub-optimal returns over time. Famed mutual fund manager Peter Lynch once quipped that “far more money has been lost by investors preparing for corrections, or trying to anticipate corrections, than has been lost in corrections themselves.”3
Bottom Line for Investors
When the market takes a sudden and sharp turn, investors often get rattled and start questioning their asset allocation. Getting worried and second-guessing is a normal, natural, and understandable response. Volatility can serve as an opportunity to review your asset allocation and make sure your portfolio is diversified and aligned with your long-term goals.
But if you’re feeling the urge to react and ‘do something about it,’ I’d strongly urge you to reconsider. If your goals have not significantly changed in the last few months, then in all likelihood, your investment portfolio shouldn’t change either.
Disclosure
2 Fred Economic Data. October 30, 2023. https://fred.stlouisfed.org/series/DGS10#
3 Acumen Wealth. April 8, 2018. https://acumenwealth.com/acumen-wealth-advisors-q1-2018-market-insights-commentary/
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