In late October, we saw many headlines claiming the stock market had officially entered a ‘correction.’ This term is often used by the financial media and other pundits to refer to a market decline of 10% or more from a prior high. This type of headline can be alarming and is frequently used to attract attention, but is this development something investors should actually care about?  

After the banking turmoil from earlier this year settled, stocks began a rapid climb higher. Between mid-March and late July, the S&P 500 gained over 20.0%. Given the average annual return for U.S. stocks has been around 10% for the last 90+ years, a 20% gain in just five months represents very strong performance. Volatility returned in July, however, and by October 27th, the decline had surpassed the 10% threshold.   

Despite the sensational headlines, periodic volatility in the stock market is not unusual. The chart below illustrates the frequency of drawdowns for the S&P 500 going back to the 1950s. A decline of -5% or more has happened regularly, about three times per year on average. Larger declines of more than -10%, like the one we just experienced, have been surprisingly common as well. These corrections have occurred about once a year. Finally, stocks have sold off by 20% or more every 6 to 7 years. Large declines of this magnitude are referred to as a ‘bear market’ and are often accompanied by a recession. 

Frequency of Market Declines

Source: Capital Group, RIMES, Standards and Poor’s. Data between 1953 and 2023. Average frequency assumes 50% recovery rate of lost value. Average length based on market high to market low.

What pushed stocks into correction territory? Even in hindsight, that question is not always easy to answer with certainty. There are probably a few different factors that have been weighing on the market.

• The selloff in the bond market has spooked investors. In October, the 10-year Treasury yield hit its highest level since 2007, briefly exceeding 5.0%.
• A few tech giants published lackluster Q3 results and/or forward guidance. These companies have a large weight in stock indices, and their decline can have an outsized impact on the market.
• It is not uncommon for the market to take a breather after a jump in prices like the one we saw in the middle of the year. A 20% gain in just five months might have been a little too fast.
• There continues to be a risk that the economy will slide into a recession within the next year.

The bigger question is, where do stocks go from here? The market narrative has shifted in recent days as investors appear to be pricing in the end of the Federal Reserve’s rate-hiking cycle. This has led to a rapid decline in Treasury yields over the last week, with stocks rallying about 6% from the recent bottom. Does this mean the worst is behind us for now? It is certainly possible.

Only one in three corrections see price declines move beyond -15%. Still, market narratives can turn on a dime, and the recent relief from volatility could prove to be short-lived. Without a crystal ball, it is not possible to accurately model the endless array of variables that influence the direction of the economy and the stock market. Nobody knows what the future has in store.

Ultimately, the takeaway here is that long-term investors do not need to care that the market slipped into correction territory. Corrections occur frequently, typically only last for a couple of months, and are a normal and healthy feature of the stock market. While volatility is uncomfortable, it must be endured to benefit from the long-term wealth-creating power of the financial markets. Owning a diversified portfolio and sticking to a financial plan puts investors in the best possible position to do this successfully.

Week in Review

• Federal Reserve officials voted unanimously to leave interest rates unchanged during their meeting last Wednesday, November 1st. This marks the second consecutive meeting of leaving interest rates unchanged, the longest period without an increase since the Fed began raising rates in March of 2022. Fed Chair Powell indicated that the committee was not discussing rate cuts at all and was instead focused on the question of whether policy was sufficiently restrictive to return inflation to its target.
• The Labor Department released the latest nonfarm payroll figures on Friday, which showed employers added 150,000 jobs in October. This number missed the estimate of 170,000 and was the smallest monthly increase since June. Three sectors, healthcare, government, and leisure/hospitality, accounted for almost all the job gains, while the rest of the economy had little to no net job growth. 
• According to FactSet, 81% of the S&P 500 has reported Q3 results as of last Friday (11/3). The earnings growth rate, blended between companies that have already reported with the estimates for those that have yet to report, is at 3.7% year-over-year. Expectations for the earnings growth rate at the onset of earnings season was -0.3% year-over-year. If the blended-rate estimate comes to fruition, it will mark the first quarter of year-over-year earnings growth for the S&P 500 since Q3 of 2022.

Hot Reads

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Markets at a Glance

Source: Morningstar Direct.

Source: Morningstar Direct.

Source: Treasury.gov

Source: Treasury.gov

Source: FRED Database & ICE Benchmark Administration Limited (IBA)

Source: FRED Database & ICE Benchmark Administration Limited (IBA)

Economic Calendar

Source: MarketWatch

IMPORTANT DISCLOSURE INFORMATION