What investors need to know about stock market corrections

Market corrections, while common, are always unsettling. Investment strategists lose sleep too. In the midst of this current global market sell-off, I spent the wee hours reminding myself of what I’ve absorbed over the years about market corrections and volatility. Here are some important reminders to keep in mind if the current sell-off is causing you to lose sleep as well.

Ten things to remember about market corrections and volatility

1. Market corrections happen almost every year. Since the early 1980s, there has been a greater than 5% drawdown in the S&P 500 Index in every year but two (1995 and 2017).¹
2. Market volatility and corrections do not emerge out of nowhere. They tend to be the result of policy uncertainty. The US market has been expecting multiple rate cuts by the US Federal Reserve (Fed), which have not yet emerged but are likely forthcoming.²
3. Of all the indicators, the bond market tends to get it right most often. The bond market is signaling that US nominal growth (real economic activity plus inflation) may be weak. US long rates have plunged.³ The 2-year US Treasury has fallen by even more.⁴ The bond market is ahead of the Fed and intimating that multiple rate hikes could be imminent.
4. Market cycles don’t die of old age. They are typically murdered by the Fed with interest rate hikes. Herein, lies the rub. Has the Fed kept interest rates high for too long, and what damage has it done to the global economy? Fortunately, many of the “early warning signals” that we track do not appear to be suggesting that a recession is imminent.
5. The corporate bond market has been the “canary in the coal mine.” Corporate borrowing costs relative to the risk-free rate tend to provide an early warning sign, rising significantly ahead of a recession. Currently, the spread between high-quality corporate bonds and the risk-free rate are rising but remain below average.⁵ In short, I believe the corporate bond market is signaling a worsening economic backdrop, but not a recession.
6. The stock market has historically recovered quickly from corrections. The average time to recovery from a 5%-10% downturn is three months. The average time to recovery from a 10%-20% correction is eight months.⁶
7. If a recession occurs, markets typically fall by more and take longer to recover. The average decline during the more-mild recessions of 1957, 1960, 1980, 1981, and 1991 is nearly 20%. The stock market recovered, on average, within one to two years.⁷
8. The best days in the market often happen near the worst days of the market. Investors likely know that returns can be significantly impaired if they miss the best days in the market, but they may not realize that the best and worst days tend to group together. In fact, of the 30 best days in the stock market in the past 30 years, 24 happened during the “tech wreck”, the Global Financial Crisis, and the COVID-19 pandemic.⁸
9. It’s typically been better to add to portfolios after severe down days. Long-term investors have usually been better served by adding to portfolios rather than by withdrawing money during corrections.⁹
10. Time in the market has generally been better than timing the market. On days when the headlines look dire, our action biases implore us to make changes to our portfolios. However, numerous studies, including one from Dalbar study, concluded that investors who remained committed to their investment plans have typically fared better than those who have attempted to time the market.¹⁰