Is The Recent Market Correction Normal?
The stock market is off to a bumpy start to the year. As of market close on Friday, the S&P 500 was 8% off its high. Other parts of the stock market were down even more – the Nasdaq tech-heavy stocks were down more than 12%, small-cap stocks in the Russell 2000 were down 18%.
I think the recent pullback is affecting some investors more than it normally would because of how calm last year was. Equity investors didn’t have to deal with much volatility at all to get extraordinary returns in 2021. This year is shaping up to be different. And it could get worse before it gets better. But let’s put this recent correction into context.
In the chart below, the dark blue bars show what the annual return was for the year. The red dot shows the largest annual decline during that year. For example, in 2021 the total return for the S&P 500 was 27% and there was a decline of 5%.
Looking at this, my biggest takeaway is just how many red dots there are. What we’re experiencing right now is perfectly normal. About 19 out of 20 years have declines of 5% or worse and nearly 2 out of 3 years have declines of 10% or worse.
Despite how regular it might be, it doesn’t make going through them any easier. Here are a few principles I remind myself of when stocks start to slip:
1 - Diversification wins. While the market is screaming up, everybody wishes they were invested in only the highest growth sectors of the stock market. But times like this remind us why we spread things out. For investors withdrawing from investments, the bonds & cash provide a source to take from while waiting for stocks to recover.
2 - Time horizon matters. There are many investors investing in the same thing but with very different time horizons. You have day traders, institutions, pension funds, retirees, millennials - the list goes on. If you structure your investments properly, the portion of your investments that are down right now shouldn’t be touched for a long time.
3 - This is, unfortunately, the cost to play the game. Stocks have earned fantastic returns of roughly 10% per year over the past 100+ years. Stock investors earn that premium return because of their willingness to deal with what we are going through right now. This is what the finance industry refers to as the “risk premium.” If these drops didn’t happen, stocks would not earn that high return. In the long run, we are better off with the volatility than without.
Thank you for reading,
Alex
This blog post is not advice. Please read disclaimers.