“Bull markets are born on pessimism, grow on skepticism, mature on optimism, and die on euphoria,” as renowned investor Sir John Templeton once said. Unlike Templeton, however, you do not need to be a Rhodes Scholar or the namesake of a philanthropic organization to know that markets are inherently volatile and prone to cycles of gains and losses.
Though past performance does not guarantee future results, markets have traditionally been cyclical. Some financial professionals viewed the performance of major market indices over the past year or so as the “euphoria” stage described by Templeton; in the 2017 calendar year, the Dow Jones Industrial Average (DJIA) increased in value by more than 25 percent.
In late January, however, investors were reminded of market volatility when stock valuations dropped significantly in a short amount of time. Though the specter of past recessions and depressions looms over these drops, let us examine what a “market correction” is and what it might mean to investors.
What is a market correction?
A correction is when a market index experiences a drop of at least 10 percent in a relatively short amount of time —often without strong underlying data correlations. Typically, a correction is viewed as an adjustment in value from a high-point in an investing landscape that is overly exuberant, not necessarily an all-out crash due to a failing economy.
The most recent correction began in late January. The DJIA had just reached its all-time high when it hit over 26,600. After this, however, the index shed a bit over 10 percent of its value over the next few weeks, falling below 24,000.
Are market corrections bad?
Whether a stock market correction is “bad” or not is a complex topic to address. For most clients, investing in securities is typically part of a long-term strategy when seeking to achieve their financial goals. If an investor keeps long-term goals in mind, short-term fluctuations may not bother them nor coerce them to alter their investing strategy.
Closely watching the balance of an investment portfolio, especially in the middle of a correction or general market downturn, can evoke an emotional reaction in investors. If investors take a more active approach in their investment strategy, a panicked sell-off will result in a loss of capital. In these cases, market corrections can be viewed as “bad,” as they will negatively impact the value of their net worth and the integrity of their long-term investing strategy.
On the opposite end of the spectrum, however, some investors view market corrections as a fire sale for stocks, enabling them to buy at lowered prices. If the stocks regain their previous value in relatively short order, investors may view market corrections as a positive.
Looking ahead, what do market corrections tend to indicate?
Like most aspects of investing, it is usually impossible to forecast what a short-term correction means. In the past, however, according to Peter Oppenheimer of Goldman Sachs, “the average bull market ‘correction’ is 13 percent over four months and takes just four (additional) months to recover.”
While the past may not always indicate the future, it is important to remember how the market has previously reacted to corrections. The past year or so has been incredibly prosperous for investors, and if the current downward trend is short-lived, investors and financial professionals across the world will still fondly remember this run.