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Is This the Start of a Stock Market Correction?

Posted by WrapManager's Investment Policy Committee
January 29, 2014

The stock market felt a sting last week, with the Dow dropping 3.5% and marking its worst week since November 2011. A majority of the decline took place on Friday, when the Dow fell some 320 points, or almost 2%. The S&P 500 slid 2.6% on the week, which was its largest weekly decline since May 2012, and technology stocks followed suit as well with the NASDAQ selling off 1.7% and posting its worst week since last August.

The sell-off last week has naturally caused some investors to wonder, is this pullback the start of a stock market correction?

Below, we’ll address that question for you and look at past stock market corrections.

Corrections Are a Normal Part of Bull Markets

That’s not WrapManager making that statement - history makes it for us! As you can see in the chart below, the average intra-year decline for the S&P 500 since 1980 is 14.4%. Put another way: for the last 34 years, the average drop within a given year for the S&P 500 is 14.4%.

The takeaway: it is normal to experience stock market declines (and sometimes big ones) in any given year, yet the market can still (and usually does) finish positive:

Historical Stock Market Correction

(Click chart for larger version) 

Historical Stock Market Corrections

Take 1980 for instance. In that year, the market experienced a 17% decline and it was probably difficult for investors to remain patient—just like it would be today if your portfolio dropped 17%.

However, from start to finish in 1980, the stock market was up just over 25%!2 Had you fallen asleep on January 1, 1980 and woken up on December 31 of the same year, you would have seen the market significantly higher, but you would’ve never known that the market actually suffered a steep intra-year decline. By contrast, investors who got spooked in 1980 and perhaps went to cash when their portfolio started declining may have missed out on a solid year.

So, Is This the Start of a Correction?

It could be, but it also might have just been a difficult week that the market will shrug off from here. It’s impossible to know for sure. Stock market corrections by definition are short, sharp declines within a bull market, and they begin—and end—unannounced. They’re unpredictable by nature.

Looking again at the chart above, you can see that in many years the market only declined by a low single digit number, like in the early to mid-1990s or even just last year. That could be the case now, though again we cannot know for sure.

Should You Adjust Your Portfolio for the Possibility of a Market Correction?

Stock market corrections have a way of giving investors the jitters, and in some cases can lead them to make emotional decisions that could adversely affect their portfolios. Think about the hypothetical investor in 1980 who was rattled during the correction and sold out of stocks, when the best strategy might have been to just stay put all year.

In the current environment, a correction this year could just be a temporary setback to what might otherwise be a positive year. This is not to say you should just sit back and ignore the market—it is important to ensure you have a properly diversified portfolio as a risk control measure. You should speak with your financial advisor to get their thoughts on the market activity, and to review your asset allocation to be sure you’re positioned properly in accordance with your investment plan.

If the market does continue to pull back, we’d encourage you not to get too caught up in the day to day, and instead remember to focus on your long-term goals. Hanging tight this year could be as valuable as it was in 1980.

Our Wealth Managers Can Discuss the Market and Your Portfolio

We’d be happy to discuss our thoughts on the market as well as review your portfolio. Give us a call today at 1-800-541-7774. If you don’t have an investment plan already, one of our Wealth Managers can work with you to create one. Simply answer a few brief questions to get started now.


1 CNN Money

2 The Standard

3 Investopedia

Stock Market Corrections