Understanding Market Corrections
The S&P 500 moved into a “correction” on Thursday of last week, defined as a close at least 10% below the index’s recent closing high. Here are some things we know about corrections, which we’ll look at in depth this week.
- Corrections are normal, the S&P 500 averaging 1.1 corrections per year since 1928.
- Corrections happen for a reason, and it’s always tempting to see that reason weighing even more on stocks. Most of the time it doesn’t. Historically, the S&P 500 has come fully out of the correction about three times as often as it has entered a bear market.
- Emotions start to run high during corrections and many investors become more prone to making costly investment mistakes.
- The best defense against corrections is to understand that they are a normal even in good markets and have a plan ready for when emotions take over, because when you’re in a correction it almost always feels like this one is the exception that justifies abandoning your plan.
These guidelines don’t mean we ignore context. In last week’s commentary, we took a look at tariff policy, the market uncertainty it was creating, and what was going on in the broader economy. But whether we’re looking at the current state of the economy or market history, our focus is always on facts over feelings.
This week we’re focusing on the history of market corrections because we think the context is extremely important and an essential starting point for understanding the current market.
Yes, the S&P 500 Is Now in a Correction
After another big down day on Thursday, stocks officially fell into a correction, with the S&P 500 down more than 10% from the February 19 peak. Although this hasn’t been fun, we can’t say it wasn’t totally unexpected, as late February to early March is one of the more seasonally weak times of the year, not to mention the first quarter of a post-election year is one of the weakest quarters in the four-year presidential cycle. Here’s a chart we’ve shared a lot that shows just this. On top of that, factor in that the first quarter after a year with a 20% gain tends to be weak and that the past 20 years the first quarter has been weak in general, and things were ripe for some volatility early in 2025.
We’ve been on record that at some point this year we’d probably see a 10% correction and here it is. No, we didn’t think it would happen this quickly, but always remember that stocks take an escalator up, but an elevator down. Declines can happen quickly.
Another popular chart we’ve shared a lot is how 10% corrections tend to happen once a year on average (shout out to Ned Davis Research for this data). Given we didn’t have a correction last year, you could say the odds were even higher we could have one this year.
Is This Normal?
Trust us, we get it. This doesn’t feel normal. We are in the middle of a seemingly escalating trade war with uncertainty dominating everything. Markets can take good news, they can even take bad news, but they hate uncertainty and we have a lot of it.
Still, over the past 46 years this is now the 24th year with at least one correction at some point during the year, meaning these corrections happen a lot. Of course, not all corrections become bear markets. We found 16 years that stocks had a correction but didn’t fall into a bear market that year (and we don’t expect a bear market this time). Over those 16 years stocks gained a solid 9.5% for the year and were higher for the year 10 times. Remember that since 1950 stocks are up 9.5% on average.
A little more color on the chart above. The average year sees a 14.0% peak-to-trough correction and the years that have fallen 10% at some point, but finished the year higher, ended up with a 17.5% average return for the year. With the S&P 500 down 4.1% for the year, there’s still time for it to get back to positive and maybe even by a large amount. Don’t give up hope just yet.
Could This Turn into a Bear Market?
Of course anything is possible, but as of now we think the odds of this turning into a bear market (down at least 20% from the February 19 peak) are quite low. For context, we found there have been 48 corrections in history and only 12 of them turned into a bear market, so only 25% have gone on to move into bear market territory.
Another Bear Now Would Be Quite Rare
If this turned into another bear market it would set a new record and we guess this would be under the “records we don’t want” category.
The S&P 500 peaked on February 19, 2020 before the Covid bear market and then we had another bear market in 2022. We’ve never seen back-to-back bears so close (only 1.9 years apart), so could we really have a third bear so soon? If we did that would be three bear markets starting within five years of each other, breaking the previous record of nearly seven years between 1966 and 1973. Again, anything is possible, but we’d say another bear this soon after the previous two isn’t a likely scenario.
Also, this decade now has two bear markets and the only other decade with three is the 1960s (based on when the bear market started). Could we really have three bear markets in only half a decade? It is possible, but unlikely.
What Should You Do?
Remember Sesame Street and the word of the day? Well, the word of the day in 2025 is “diversify”, as portfolios that have been diversified have held up quite well.
The “Magnificent 7” megacap technology-oriented stocks did great the past two years, but they’ve been hit hard this year, reminding all of us why it is important to stay diversified. In fact, yes, the S&P 500 is down more than 4% for the year, but core bonds are up a couple percent, long Treasuries are up close to 4%, gold is up double digits, seven of 11 S&P 500 sectors are higher this year, and most European market are up in the upper teens or more.
Know that volatility is the price we pay to invest and stay the course and stay diversified. In 2023 and 2024 it made more sense to be heavily in stocks, and the big US technology-oriented names in particular, but with many of the growing worries, there is nothing wrong with having a portfolio that will help you sleep at night, but don’t panic and sell after a few bad days.
A Valuable Reminder
We’ll leave you with this always popular reminder. If you miss out on the 10 best days of the years historically, you will miss out on significant gains. The catch is the best and worst days usually happen close to each other! So if you have to sell after the worst days, it likely means you will miss out on the eventual coming best days. We saw this just last week: Monday last week was the worst day of the year so far, but Friday was the best. Last year stocks gained more than 23% but if you missed the 10 best days that drops to less than 4%. Same thing for 2023. In fact, the average year since 2000 has gained 9.5%, yet drops to negative 12.5% if you missed the best 10 days of the year, a more than 20% drop!
We know this correction doesn’t feel good. Corrections never do. But understanding market history is an important aid to making the decisions needed to achieve long-term investing goals.
This newsletter was written and produced by CWM, LLC. Content in this material is for general information only and not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly. The views stated in this letter are not necessarily the opinion of any other named entity and should not be construed directly or indirectly as an offer to buy or sell any securities mentioned herein. Due to volatility within the markets mentioned, opinions are subject to change without notice. Information is based on sources believed to be reliable; however, their accuracy or completeness cannot be guaranteed. Past performance does not guarantee future results.
S&P 500 – A capitalization-weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.
The NASDAQ 100 Index is a stock index of the 100 largest companies by market capitalization traded on NASDAQ Stock Market. The NASDAQ 100 Index includes publicly-traded companies from most sectors in the global economy, the major exception being financial services.
A diversified portfolio does not assure a profit or protect against loss in a declining market.
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