Insights & Advice

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Our First Big One

The stock market’s sell-off this week amidst high volatility has triggered worries among investors that we were heading right back into those bad old days of 2008-2009. Those fears are understandable given that for the first time since the markets bottomed in March of 2009, we are having our first official correction.

Most market participants consider a decline of between 10-19% an official correction. A decline of 20% or more decline indicates the next more serious stage of sell-off called a bear market although I would be a little more flexible in my ranges. A market could overshoot a decline by 2-4% and still be in a bull market, for example. So far we’ve incurred an almost 16% decline when measured by the S&P 500 Index. We’ve had previous pullbacks over the last year or so (called dips), but none of them amounted to more than a mid-7% decline.

The Greek debt problems coupled with the fear of further contagion among other European nations, was the most obvious trigger that precipitated this decline. Of course, the move by China, India and Brazil, who fear a jump in inflation, to restrict lending and/or raise interest rates also worried investors. The huge appetite from these countries for all sorts of goods and services over the last year had helped pull the world out of recession. Investors are afraid that demand would slow or even stop.

Bad news has a way of coming in spates. Consider that over the past few months we’ve also experienced the gulf oil spill, the uncertainty over the financial reform bill and recently the tiff between the two Koreas. This has all weighed heavily on the markets. As this bad news piles up, more and more investors are beginning to fear a worldwide double dip recession. I don’t think that will happen. The increasingly steady stream of good economic numbers generated by our own recovery convinces me of that fact. Yet the stock market, at its high of 1220 certainly has discounted a lot of that economic recovery already.

This correction has been both painful and abrupt but it is altogether typical of past corrections in bull markets. The average length of time from the beginning of a rally to its first correction is 17 months, according to Fidelity Research. This correction started in April, the 14th month of the rally. But at the same time the price appreciation of the market has been outsized, gaining 80%, well above the average of 57%. In my opinion, given those gains, we were overdue for a good old-fashioned correction.

The good news is that this correction has been fairly swift. The first 10% decline took 27 days. That’s about half the average length of time of most market corrections. Over the last 84 years there have been 20 corrections in which the market corrected betwen10-19% but did not move into bear market territory.

Now, I do not believe that this correction is over, despite the recent strong gains in the market. There will continue to be volatility and I expect that at some point soon we may actually see the high 900s on the S&P. That could mean a correction of as much as 19%. But that is still not the end of the world although it may feel like it. If you do not feel comfortable with that kind of decline, I would suggest raising some cash on any market bounces that come our way.

Posted in A Few Dollars More, Portfolio Advice