The stock market decline picked up steam last week as big tech earnings lacked enough good news to placate investors. The week was filled with negative sentiment and the S&P 500 transitioned from a mild pullback to a more severe correction within the current bull market that began on October 13, 2022.
Since July 27th the S&P 500 has been in a pullback (a drop of 5-10%) but entered a correction late last week (a drop of 10-20%) with the S&P 500 down 10.9%. The often more volatile Nasdaq Composite Index topped out on July 18th and is now down 13.2%. This correction is a bit of a head scratcher since the underlying economy is doing well with 3rd quarter GDP at 4.9%, unemployment very low, and strong consumer spending. One thing pullbacks and corrections have in common is that they are based more on negative sentiment than on fundamentals.
By researching market cycles since 1942, we can look at what the highest probability outcomes are for how far the market may drop and for how long before it reverses direction. Since 1942 the overall ratio of pullbacks to corrections is 3 to 1, with 108 pullbacks versus 36 corrections. A significant 86% of the time the drop does not exceed 12%, and 93% of the time the drop does not last longer than 70 trading days (currently 67 days). The research shows that odds are strongly in favor for this correction to end sooner than later but probabilities can’t predict the future, they only show us the more likely outcome.
Another possibility, but very low probability, is that the presumed bull market that began October 13, 2022 wasn’t in fact the start of a bull market but simply a rally within a larger bear market. I believe this scenario is a very low probability because that would mean the bear market is over 21 months old and these cycles don’t usually last that long. There have been 14 bear markets since 1942 and only 2 have lasted over 21 months. Once again, probabilities can’t predict the future but investing with the odds in your favor gives you the highest chance for better profits.
I continue to see this correction as an opportunity to invest excess cash while prices are low.
Photograph by: Avery Cocozziello on Unsplash
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