“Correction” is one of those euphemisms Wall Street likes to use that would be funny if it weren’t so painful.
According to CNBC, a correction is “a decline or downward movement of a stock, or a bond, or a commodity or market index” of at least 10%, although a “true correction” exceeds that amount. Others define a correction as being a decline of at least 5%.
While markets are supposed to be “efficient,” with prices at all times reflecting the true value of the underlying assets, the term “correction” implies that mistakes were made—and the market is correcting them at your expense, even though you didn’t do anything wrong.
For some reason, markets only correct down, never up.
A correction can be enough to cause panic attacks in queasy investors—especially today’s investors, who have become accustomed to the lack of volatility they’ve enjoyed in recent years—but it’s a normal adjustment in the market and it’s bound to happen periodically. Since 1932, we’ve had 30 corrections of 10% or more and 109 of 5% or more, according to Equities.com.
A correction is nowhere near as panic-worthy as a bear market, which is something we haven’t witnessed since the Great Recession. A bear market represents a decline of 20% or more.
A bull market exists until it becomes a bear market, so we are still in the second-longest bull market ever. Keep that in mind before you panic about the sudden volatility that’s hit the stock market.
24 Years, Not 24 Hours
As of Jan. 26, the Dow Jones Industrial Average (DJIA) was at a record high of 25,616.71 and the market was off to its best start in 31 years. A record 1,175-point decrease in the DJIA on Feb. 5 reminded many that markets can be volatile, and they certainly have been since then.
Volatility continued on April 2, when the DJIA ended the day down 458.92 points. With the DJIA at 23.644.19, that was a drop of 8.34% from the peak, which some wouldn’t consider to be large enough to qualify as a correction. Regardless, the market uncorrected the next day, with the DJIA moving up 389.17 points (1.65%) to regain most of the previous day’s loss.
After the Great Recession, markets seemed to respond primarily to the actions (or inactions) of the Federal Reserve Board. The Fed continues to have an impact on the markets, but so do many other economic factors. Tax reform and deregulation pushed stock prices higher at the beginning of 2018. The threat of a trade war, President Trump’s attack on Amazon’s shipping arrangement with the U.S. Postal Service and other factors have played more of a role recently. The potential for the Fed to raise interest rates more rapidly than previously anticipated also continues to be a factor.
Ironically, one reason that a significant drop in stock prices appears so extreme today is that the DJIA has reached such a high level.
On April 7, 1978, the DJIA was at 769.58. A 458.92 point drop then would be a disaster, as it would represent two thirds of the market’s value. Consider that since then it has grown by a factor of more than 31!
Conversely, the 508-point slide in the DJIA on Oct. 19, 1987 wouldn’t seem so drastic today. On that date, which became known as Black Monday, the DJIA dropped 22.61% to 1,738.74.
“Instead of focusing on the past 24 hours,” David Bach, co-founder of AE Wealth Management was quoted as saying in Investment News, “we tell investors to focus on the past 24 years, and then to look forward to the next five-to-10 years.”
We all want to believe in fairy tales, such as the stock market only goes up, the U.S. will always be the dominant world power and you’ll never lose money when you invest. But there are no such thing as fairies and, yes, markets move in both directions.