There’s a lot going on in the world right now.
War, rising oil prices, high energy costs, rising inflation expectations, a possible pause in the Fed’s rate cuts, the development of artificial intelligence, a slowing labor market, the software apocalypse, and more.
The collective reaction from the stock market has been a relatively shallow correction so far.
The S&P 500 is down just 6.8% from its peaks at this year’s low point:
In the words of Derek Zoolander:
Given what’s going on in the world, it seems like this decline should be worse than that.
In fact, you can’t even call it a fix yet. This is a retreat.
Here’s my unscientific definition of stock market downturns:
-5% = withdrawal
-10% = healthy correction
-15% = correction
-20% = bear market
-30% = collapse
-40% = collision
-50% = crisis
Withdrawals occur quite frequently. Here are the number of 5% withdrawals by year from 1990 to 1990: Annex A:
Only 3 of the past 37 calendar years have not experienced a retreat of at least 5%.1
Here’s a look at the totals for other downtrends dating back to 1928:
Frankly, healthy corrections happen more than accidents. A 10% correction occurred approximately every 1.8 years. A bear market occurs approximately every 5 years.
It’s also interesting to think about how often each level occurs. another level.
Let’s say you get a healthy 10% correction in the S&P 500. How often has this turned into a 15% correction?
Reply: 54% of the time.
How many times has a 15% correction turned into a 20% bear market?
Reply: 73% of the time.
How many times has a 20 percent bear market led to a 30 percent crash?
Reply: 59% of the time.
How many times has a 30% crash turned into a 40% crash?
Reply: 54% of the time.
So how many times has a 40% crash turned into a 50% crash?
Reply: 43% of the time.
Of course, these are historical possibilities. They don’t tell us anything about what will happen in the future. This is the hard part.
It is impossible to know in real time when a pullback will turn into a healthy correction. Fundamentals won’t help you determine when a bear market will turn into a full-blown crash scenario.
When stocks are falling, the only variables that matter are human nature and how investors react to the world around them.
Will the retreat worsen, leading to a health recovery, a bear market, a crash, a crash, and eventually a crisis?
At some point it will. This could be a decade or a few years from now.
From here, things can always turn around or get worse. This is one of the many reasons why the stock market offers you a risk premium as an investor in the long run; unpredictable in the short term.
Successful long-term investing in the stock market requires accepting the inherent uncertainty of how large losses will be in the short term.
The graph never moves up and to the right in a straight line.
Further Reading:
Do We Need to Make Corrections?
1The worst decline from peak to trough, last in 2017, was just -2.8%. It was an easy year.
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