Is The Correction Over? No Evidence Yet
Beginning August 20th, the S&P 500 declined over 10% in 4 trading days. While a 10% drop is the unofficial definition of a typical correction, the speed at which the decline came was rare. In fact, since 1965 there have only been 5 other “events” that included a 10% correction in just 4 trading days: 1987, 1998, 2002, 2008, and 2011.
We examined those past events to see what we could learn. The accompanying chart shows the last 5 events 3 months before and 3 months after their 4-day drop. Our first takeaway?
In 4 of the 5 historical events, the S&P 500 showed gains 3 months later, while 1 event (2008) led to deeper losses. Last week, we heard many market pundits point to data like this to encourage investors that a rebound was likely.
But we also see a second key point. Note how the historical 5 events occurred after stocks had already corrected the previous 3 months. In other words, the 4-day drop took place after the market had already booked an average decline of 6% (including a 19% drop in 2002). So the 4-day drop of 10% or more historically marked the end of a correction, or the often-cited “point of capitulation”. Once investors capitulate and sell, future gains are likely, as the chart shows.
But last week’s 4-day drop wasn’t part of an ongoing correction. The S&P 500 was down a mere 1.5% the previous 90 days. With this perspective in mind, calling this correction over seems premature, doesn’t it?
Of course, we make our portfolio decisions using objective data and evidence. Although we don’t believe another 2008 is likely, we don’t see evidence that the market correction is over. Market technicians would point out that, for a correction to conclude, a successful re-test of recent lows must occur. If you look closely at the chart, you can see this taking place (dotted red line) about a month after the 4-day drop.
So, we will continue to deploy our evidence-based investment process and position portfolios accordingly. We’ll let others attempt the market heroics for which Wall Street is so commonly known and focus on delivering results that fulfill our clients’ financial plans. Shouldn’t you?