That was fast! The S&P 500 entered correction territory on March 13th after hitting an all-time high on February 19th. Then, April 7th-9th we went into an intraday bear market (this doesn’t actually count as a bear market because the market never closed down more than 20% … love those semantics) and immediately bounced +9.5% in one day when President Trump changed his tune on when tariffs would go into effect.
So, what does this all mean? The finance industry loves its jargon; they like to spout off the next piece of information meant to scare you so you can’t look away from your television/device. I want to start by defining three commonly used terms to understand what’s happening in the markets. Then, I will share some positives I see in investment land.
A pullback is a term used to describe the stock market falling between 5-10%. Investopedia defines a pullback as “a temporary reversal in the upward price trend of a stock or other investment that typically only lasts a few consecutive sessions.” You might also hear words like “retracement” or “consolidation,” but as we move forward, it just means that stocks are down 5-10%. Historically, you should expect 2-4 pullbacks per year.
A correction describes the stock market falling between 10% and 20%. I’m unsure how or why the word came into use, but it makes no sense if you think about it. Correction implies that there is a “correct” price level for a stock market and that investors thought prices were too high, so they collectively decided to bring stocks back to the “correct” level. I’m sorry to say that after being in this industry for 20 years, “the market” doesn’t know the “correct” price for anything. Companies are always innovative and looking to grow earnings over time, so stock prices tend to move higher in the long run. Historically, you should expect one correction per year when investing in stocks.
Lastly, a bear market describes when stocks are down 20% or more. Bears and bulls have historically been used to describe stock market movements because of how animals attack. Bears attack with their paws from high up and swipe down. Bulls lower their horns and thrust upwards. These occurrences are much rarer but still happen every 5-7 years historically.
With that as a backdrop, let’s discuss what’s happening in the market now. As I said in the opening paragraph, we experienced one of the fastest corrections in history in February and March, with only 16 trading days. Chart 1 shows other “fast” corrections over the last 75 years. In almost every case, the market is higher 12 months after, and you’re up significantly more than the average one-year gain historically (up 13.7% on average after a “fast” correction versus 9.2% on average). The only time the market was down one year later was during the “Tech Wreck” in the early 2000s.
One of the Fastest Corrections Ever, Now What?
S&P 500 returns after quickest moves into a correction (From all-time high to 10% off peak)
CHART ONE: Sources – Carson Investment Research, FactSet 3/16/2024 (1950-Current)
Speaking of the “Tech Wreck,” that “fast” correction happened as the economy fell into recession. Now, let’s look at every correction since 1950 that didn’t turn into a bear market. Chart 2 shows that if a correction doesn’t turn into a bear market, we should expect good returns for the following year. In fact, it’s an even better return than after a “fast” correction (14.7% on average).
What Happens After Stocks Move into a Correction?
S&P 500 returns after 10% off all-time highs, but doesn’t go into a bear market
CHART TWO: Sources: Carson Investment Research, FactSet (1950-Current
Unfortunately, we don’t know if this correction will become a bear market. However, we know that a correction turns into a bear market only 25% of the time. Since World War II, the S&P 500 has experienced 48 corrections, and only 12 have turned into a 20% bear market. The market often tries to predict bear markets, but the success rate is relatively low.
Another unprecedented occurrence would be how quickly we’ve experienced our most recent bear markets. Chart 3 shows that since 1950, on average, bear markets are 6.7 years apart. The last bear market began on January 3rd, 2022. If this is the beginning of a bear market, it’s only been 3.1 years since the last one. Even more unprecedented would be the space between three bear markets. On average, three bear markets are spaced out 13.7 years apart. If this is, in fact, a bear market, this would only be five years from the COVID bear market of 2020.
Another Bear Market Right Now Would be Extremely Rare
S&P 500 Index Bear Markets (1950- Current)
CHART THREE: Sources – Carson Investment Research, YCharts
Now, all these statistics may not make anyone feel better. That’s the hard part and what they call the “price of admission” for investing in stocks. In finance, they call it the “equity risk premium.” You must live through all of these pullbacks, corrections, and bear markets (the risks) to reap the rewards of investing in the stock market (the premium returns over bonds or cash).
Right now (4/21), the S&P 500 is down about 16.5% from the all-time high, teetering on the edge of a correction and a bear market. There is a lot of uncertainty regarding the tariffs, ongoing trade deals, and economic progress over the coming months. These times are never easy to live through, so I will share what we recommend to all clients in times like this. First, turn off the news and don’t check your account statements. Headlines are meant to target your emotions. It’s better to look at history and trends when making investment decisions rather than reacting to the media’s commentary. Also, you don’t realize a loss in your investments unless you sell. Therefore, staying the course through this uncertainty will make you feel better in the long run. Secondly, remember your future. This is a technique I use in my everyday life, where instead of thinking about what’s happening right now, I think about myself in the future. I’m confident that future me (say 1-3 years from now) will look back and see this moment as an opportunity and not a time filled with anxiety and uncertainty. Lastly, consider Warren Buffett’s advice: “Be fearful when others are greedy, and greedy when others are fearful.” Current sentiment is extremely fearful, so let’s be greedy instead.
Diversification Is Back!
For years, we’ve been discussing diversification as a key tool in constructing portfolios … all the while, it paid not to diversify. The thing about diversification is that you’ll never know when you’ll need it, but in the long run, it always pays to have it. During the S&P 500’s 10.1% pullback, developed international stocks (as measured by the MSCI EAFE Index) were up 0.3%, emerging markets stocks (as measured by the MSCI Emerging Markets Index) were down only 2.7%, and bonds (as measured by the Bloomberg US Aggregate Bond Index) were up 1.4%. As of this writing (4/21), here are the year-to-date returns of these four indices:
- S&P 500: -13.2%
- MSCI EAFE (developed international stocks): 5.9%
- MSCI EM (emerging markets stocks): -0.6%
- Bloomberg US Aggregate Bond: 2.0%
Diversification pays off in spades during these times of pain. We will never abandon the principle of diversification because long-term investing is about accepting good enough while missing out on great but avoiding terrible.
If you have any questions or your financial situation has changed (beneficiaries, income needs, investment objectives, time horizon, risk tolerance, etc.), please contact our office. Thank you for your continued trust in KWB Wealth.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and cannot be invested into directly.
KWB Wealth is an SEC registered investment adviser. This material is solely for informational purposes. Advisory services are only offered to clients or prospective clients where KWB and its representatives are properly licensed or exempt from licensure. Past performance is no guarantee of future returns. Investing involves risk and possible loss of principal capital. No advice may be rendered by KWB unless a client service agreement is in place.
The Standard & Poor’s 500 Index is a capitalization-weighted index of 500 stocks designed to measure the performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.
International and emerging market investing involves special risks such as currency fluctuation and political instability and may not be suitable for all investors.
The MSCI EAFE Index is a free float-adjusted market capitalization index that is designed to measure the equity market performance of developed markets, excluding the U.S. and Canada. The MSCI EAFE Index consists of the following developed country indices: Australia, Austria, Belgium, Denmark, Finland, France, Germany, Hong Kong, Ireland, Israel, Italy, Japan, the Netherlands, New Zealand, Norway, Portugal, Singapore, Spain, Sweden, Switzerland, and the UK.
The MSCI EM (Emerging Markets) Index is a free float-adjusted market capitalization-weighted index that is designed to measure the equity market performance of emerging market countries across the Americas, Europe, the Middle East, Africa, and Asia. The MSCI EM Index includes indices from Brazil, Chile, Colombia, Mexico, Peru, Czech Republic, Egypt, Greece, Hungary, Poland, Qatar, Russia, South Africa, Turkey, United Arab Emirates, China, India, Indonesia, Korea, Malaysia, Philippines, Taiwan, and Thailand.
The Bloomberg U.S. Aggregate Bond Index is an index of the U.S. investment-grade fixed-rate bond market, including both government and corporate bonds.
No strategy assures success or protects against loss. The economic forecasts set forth in this newsletter may not develop as predicted, and there can be no guarantee that strategies promoted will be successful.