All You Wanted To Know About Stock Market Corrections

All You Wanted To Know About Stock Market Corrections

January 28, 2022
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2022 has been one of the worst starts to a year ever for stocks. As of January 25, 2022, the S&P 500 is down 9.2% (on a closing basis) from the peak earlier this year, suggesting we are inching closer to a potential market correction of 10%, the first since March 2020.

In fact, it took the S&P 500 Index only 15 trading days to be down 10% for the year (on an intraday basis), one of the fastest ever as you can see here.

The action so far this week has been quite memorable as well, as both days saw stocks down significantly, only to recover later in the day, well off the lows. Incredibly, Monday was only the third time in history the S&P 500 was down 4% at the lows and then finished higher.

We know why this is happening. The market is repricing risk with the realization that rate hikes are coming, likely as many as four hikes this year are being priced into the equation. Add on the continued supply chain issues, shortages, inflation, and a slowing economy due to the Omicron variant, and you have many reasons to think stocks could be down.

But one other reason stocks are down so far this year is that is just what they do sometimes. “Contrary to what many investors think, stocks do go down as well,” explained LPL Financial Chief Market Strategist Ryan Detrick. “Remember, we haven’t seen a 10% correction since March 2020, a long stretch without a normal break. Last year really spoiled new investors, as we only had a single 5% pullback all year, which isn’t normal and means investors should buckle their seatbelts in 2022.”

The average year sees nearly three separate 5% corrections, putting in perspective just how rare last year was with only one and why greater volatility this year would be quite normal.

Taking it out to 10% corrections, the S&P 500 has about one per year, but again, we haven’t seen one of those since March 2020. There was a 9.6% correction in September 2020, but that’s as close as we got. With the S&P 500 currently down 9.2% from the peak earlier this year, we could be looking at our first correction quite soon. But again, is this really surprising? Investors who came into 2022 with a plan likely anticipated the chances of a double-digit correction at some point in the year, so this shouldn’t be a major shock.

Add to that the fact that midterm years tend to be quite volatile. In fact, the S&P 500 typically sees a 17.1% peak-to-trough decline during a midterm year, the largest pullback out of the four-year Presidential cycle. The good news? A year later stocks are up more than 32% on average. No pain, no gain.

Lastly, here’s our LPL Chart of the Day. It shows all the 10% corrections since 1980, bringing back some interesting memories for long-time market watchers. What stands out is the future returns are extremely strong: A year later, up 25% on average and higher 90% of the time. This analysis reminds us that panicking in the face of weakness probably isn’t the best way to reach longer-term investment goals. Take note, this resets once the S&P 500 has a 10% rally; that is why you likely don’t see some of the 50% haircuts after the tech bubble and Financial Crisis.

For more on the rough start to this year and what is likely needed for a bottom to form, please watch the latest LPL Market Signals podcast with Jeff Buchbinder and Ryan Detrick, as they break it all down.

 

 

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All index and market data from FactSet and MarketWatch.

This Research material was prepared by LPL Financial, LLC.

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