A Brief History of Stock Market Pullbacks
There is a lot going on in the world right now.
War, rising oil prices, high energy costs, rising inflation expectations, a possible pause in Fed rate cuts, the creation of AI, a slowing labor market, a software apocalypse and more.
And the collective response from stock markets has been the shallowest correction to date.
The S&P 500 is down just 6.8% from its highest point this year:
According to Derek Zoolander:
It feels like this downturn should be worse than this given everything going on in the world.
In fact, you can’t even call this a fix yet. To step back.
Here is my unscientific explanation of stock market declines:
-5% = regression
-10% = healthy adjustment
-15% = adjustment
-20% = bear market
-30% = fall
-40% = crash
-50% = disaster
Pullbacks happen more often. Here’s a 5% annual regression figure going back to 1990 in Exhibit A:
Just 3 of the last 37 calendar years without at least 5% deferment.1
Here’s a look at some of the other decline rates going back to 1928:
Obviously, a healthy fix happens more than a crash. A 10% correction occurred about once every 1.8 years or so. A bear market comes once every 5 years or so.
It’s also interesting to think about how often each level goes another one level.
Let’s say you experience a healthy 10% correction in the S&P 500. How often does that turn into a 15% correction?
Answer: 54% of the time.
How many times has a 15% correction occurred in a 20% bear market?
Answer: 73% of the time.
How often does a 20% bear market fall in a 30% fall?
Answer: 59% of the time.
How many times has a 30% crash developed into a 40% crash?
Answer: 54% of the time.
And how many times has a 40% crash escalated into a 50% problem?
Answer: 43% of the time.
Of course, these are historic opportunities. They don’t tell us anything about what will happen in the future. That’s the hard part.
In real time it is impossible to know when a pullback will turn into a healthy correction. Fundamentals will not help you determine when a bear market will turn into a full-blown crash.
When stocks go down the only variable that matters is human nature and how investors react to the world around them.
Will the pullback get worse and lead to a health correction, a bear market, a crash, a crash and finally a crisis?
Sometimes it will be. It could be this decade or a number of years from now.
Things may go on or get worse from here. This is one of the many reasons the stock market gives you a risk premium as an investor over time – the short run is unpredictable.
Successful long-term investing in the stock market requires accepting the inherent uncertainty of how big losses will be in the short term.
The chart never goes up to the right in a straight line.
Further reading:
Should We Be Corrected?
1Last year in 2017 the highest drawdown was -2.8%. That was an easy year.
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