Market corrections: from fear to opportunity
Sadiq S. Adatia, Chief Investment Officer
After hitting bottom on March 9, 2009 in the depth of the financial crisis, the bellwether S&P 500 turned around and launched into one of the greatest bull runs in history, posting a 376% gain at the end of 2017. It wasn’t straight up – along the way there have been five nerve-fraying corrections with the market falling by more than 10% each time.
The latest market correction (defined as a 10% to 20% drop) began on January 26, 2018, with the selloff reaching 10% at its lowest point on February 8, and has been followed by heightened volatility.
Perhaps because the correction was sudden and deep, the noise around it seemed particularly loud and gloomy. But if history repeats, this correction (which is still playing out) may turn out to be another dip in an ongoing bull market.
Unfortunately, investors, whipsawed by the extreme volatility corrections cause, often sell and head to the sidelines. That’s why it’s important to realize that despite all the drama, corrections are common and can be brief.
In fact, between 1945 and the current selloff, the S&P 500 has gone through 24 corrections, with the index falling by 13% on average over a four-month period. And it took four months on average for the S&P 500 to move from the low it reached in the correction back to its previous peak.1
Market corrections in the great bull market
The four previous market corrections in the current bull market have followed the same pattern, with the market falling, before moving on to new highs. Will the latest correction play out the same way? Only time will tell, but market history suggests it may.
|Correction||Drop||Length (Months)||Return to previous high (Months)|
|April. 23, 2010 to July. 2, 2010||-16%||2||4|
|April. 29, 2011 to Oct. 3, 2011||-19%||5||5|
|May 21, 2015 to Aug. 25, 2015||-12%||3||3|
|Nov. 3, 2015 to Feb. 11, 2016||-13%||3||3|
|Jan. 26, 2018 to Feb. 8, 2018||-10%||?||?|
S&P 500 with returns calculated on a cumulative daily return basis from March. 9, 2009 to March.1, 2018 in U.S. dollars with dividends reinvested after deduction of any withholding tax.
Source: Sun Life Global Investments.
From lows to new market highs
Historically corrections have shaken excesses out of the market, before it ultimately moves on to another high. This is generally how markets have performed in the post-Second World War era, with rallies following a correction lasting almost 500 trading days on average, moving from the market bottom through the previous high to a new market peak.2
Clearly, the investing expression “buy the dip” has had some credence to it. In fact, during this period an investor who bought the S&P 500 in a correction when it was 10% below its peak would have earned a median return over 3-, 6-, and 12-month periods of almost 6%, 12%, and 18%, respectively.3
When the bears arrive
Corrections can definitely turn into bear markets, defined as a market loss greater than 20%. The S&P 500 has breached this 20% barrier 11 times since 1945, with the pullback lasting on average 13 months with an average loss of 30%.4 By comparison, the last bear market, triggered by the 2008 financial crisis, lasted for almost 17 months with the S&P 500 losing over 50% of its value.
Could the current correction turn into a bear market? It’s always a possibility, but historically severe downturns usually occur when the economy is either near, or in recession, and corporate earnings fall. At this point, the opposite seems to be true – the global economy has been accelerating and corporate earnings appear robust.
Comparing bear markets and corrections
Since 1945: Average performance, length of downturn and recovery
|Drop||Length (Months)||Return to previous high (Months)|
Source: Goldman Sachs Global Investment Research
Our view on the current market correction
As we have in the past, we see the current correction as a healthy pullback in a market that needed to blow off some steam after a sharp run up. In fact, we believe the fundamentals that have supported one of the longest market rallies in history haven’t really changed.
For starters, the International Monetary Fund has revised its economic outlook upward to 3.9% for the global economy in 2018 and 2.7% for the U.S. On top of that, the tax cut package passed by the U.S. Congress at the end of last year may give the country’s economy an added boost and help keep earnings healthy.
Indeed, in his testimony before Congress in February, U.S. Federal Reserve Chair Jerome Powell said, “the economic outlook remains strong, and some of the headwinds the U.S. economy faced in previous years have turned into tailwinds.”
Powell also suggested that interest rates would rise slowly, with many economists predicting three or four, 25 basis point increases by year-end. Even so, this would still leave us in a relatively low-interest-rate environment and continue to support underlying fundamentals
We have recognized the strength of the U.S. economy, and have increased and decreased our exposure to U.S. equities at different times. For example, in late January when our sentiment indicators moved into excessively bullish territory, we used options to hedge our overweight equity position in our Sun Life Granite Managed Portfolios. When the market tumbled, we took profits on the hedge. We then increased our equity weighting across the board, including adding exposure to U.S., European and emerging market equities. Again, we used an options strategy to reduce risk.
And our decision to invest in the midst of a correction underscores this fact: If you’re in the market, you will likely experience a correction. If you do, as we’ve shown here, often the best strategy is to simply stick to your long-term investment goals.
1, 3, 4 Goldman Sachs Global Investment Research
2 Wells Fargo Asset Management
Sun Life Granite Managed Portfolios invest in mutual funds and/or exchange traded funds (ETFs). Commissions, trailing commissions, management fees and expenses all may be associated with mutual fund investments. Investors should read the prospectus before investing. Mutual funds are not guaranteed, their values change frequently and past performance may not be repeated.
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