The sharp declines and sharp recoveries in the stock market this past week was emotionally draining for many investors. The only people that benefited from the significant increase in volatility over the last few weeks were the financial media. Given the positive fundamentals and market environment we described in our note last week, we still see this as a ‘market event’ and not the beginning of a bear market. Importantly, we can assure you that we are continuously are reviewing our trusted indicators and data to evaluate our market views.
What do corrections “look” like?
In looking at corrections historically, we look at corrections in terms of magnitude and duration (peak to trough). A few observations to note:
- The average correction lasts 188 days and total decline is 13.87%.
- The three shortest corrections lasted 18, 20 and 28 days.
- The larger the percentage decline, the longer it takes to bottom.
- For corrections with a below average price decline, the duration is 86 days, whereas for above average price declines, the peak to trough is 156 days.
Anatomy of a Market Correction (S&P 500)
Even those unfamiliar with technical analysis can see the simple patterns – corrections typically start with a sharp decline, a ‘bounce’ and then the S&P 500 either makes a new low over the coming months, or at the very least, ‘tests’ the low by trading down towards the low. Technical analysis/charts provide signals about investor psychology, which in our view, is what ‘drives’ markets over the short term. Let’s dig deeper into each “move”:
- Initial low: Markets go through a ‘shock and awe’ scenario where prices decline rapidly.
- Bounce: Investors see prices 5-10% cheaper than a few days or few weeks ago, begin to buy because there is a “sale”.
- New low/testing the low: Prices decline rapidly, usually resulting in an environment where selling is exhausted – everyone who wants to get out sells. There are two causes of the secondary low/testing the low:
- Investors that see the correction as the start to a bear market and upon prices rising, take the opportunity to “get out” and sell into the temporary strength.
- Market volatility does not subside quickly in markets (it lingers!) and the elevated levels of volatility create anxiety, which typically results in a declining market.
- Ultimate low: Long-term and objective investors conclude that the correction is not a bear market, but simply a market event and over time, the market will recover. Buying ensues, but due to the selling exhaustion mentioned previously, the buyers are more urgent than the sellers, so prices rise quickly. Optimism breeds more optimism, and eventually, prices continue to rise in a self-reinforcing loop.
So – where are we now? In our view, the recent recovery from midday Friday may not represent the final low. The intraday low on Friday did not produce the exhaustive selling spike / buying surge that is consistent with an ultimate low and subsequent recovery. Additionally, as shown in the above data regarding past corrections, if the low was made Friday, it would be the shortest correction in over 50 years. We see more sideways trading and potential for continued volatility in the near term. However, as we had mentioned last week, this correction is within the environment of a growing economy so we do see this as a “normal” correction within a bull market.
Source for all data: Bloomberg
GIS is a team of investment professionals registered with HighTower Securities, LLC, member FINRA & HighTower Advisors, LLC a registered investment advisor with the SEC. All securities are offered through HighTower Securities, LLC and advisory services are offered through HighTower Advisors, LLC.
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Scannell Wealth Management is registered with HighTower Securities, LLC, member FINRA and SIPC, and with HighTower Advisors, LLC, a registered investment advisor with the SEC. Securities are offered through HighTower Securities, LLC; advisory services are offered through HighTower Advisors, LLC.
This is not an offer to buy or sell securities. No investment process is free of risk, and there is no guarantee that the investment process or the investment opportunities referenced herein will be profitable. Past performance is not indicative of current or future performance and is not a guarantee. The investment opportunities referenced herein may not be suitable for all investors.
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This document was created for informational purposes only; the opinions expressed are solely those of the team and do not represent those of HighTower Advisors, LLC, or any of its affiliates.