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Opinion: If stocks suffer another correction, start worrying

MarketWatch logo MarketWatch 10/16/2018 Howard Gold

Editor's note: The opinions in this article are the author’s, as published by our content partner, and do not necessarily represent the views of MSN or Microsoft.

Over the weekend friends and family members asked me what was going on with the stock market. My answer was: How should I know?

As of last Thursday’s close, the Dow had fallen 6.6% from its Oct. 3 record high, the S&P 500 had slid 6.9% and the Nasdaq had lost 9.6% from its Aug. 31 peak, near the 10% decline pundits usually define as a correction. 

I’ll tell you a little secret: We commentators aren’t always 100% certain about what we write, and we often make our best guesses. Earlier this year, I was pretty convinced we were in a correction, not a new bear market. That turned out to be right. This time around, I’m not so sure.

So what am I worried about? If this sell-off turns into a 10% decline, it would be the second such correction within eight months, which I fear would mean this nearly decade-old bull market is really in trouble. That’s why I’ve gone back over the history of previous corrections to see what they showed.

The table below indicates that since 1980, not including bear markets, there have been 13 corrections. The average correction loss was 14.6% and its average duration was 80 days. (I included 1990’s 19.9% decline, which some people classify as a bear market.)

Stock market corrections since 1980
Date range Percent decline Duration (number of days)
Jan.-Feb. 2018-10.2%13
Nov. 2015-Feb. 2016-13.3%100
May-Aug. 2015-12.4%96
April-Oct. 2011-19.4%157
April-June 2010-16.0%70
Nov. 2002-March 2003-14.7%104
July-Oct. 1999-12.1%91
July-Aug. 1998-19.3%45
Oct. 1997-10.8%20
July-Oct. 1990-19.9%87
Jan. 1990-10.2%28
Oct. 1983-July 1984-14.4%288
Feb.-March 1980-17.1%43
Average -14.6% 88
Shows declines of 10% to 20% in S&P 500, not including bear markets. Source: Yardeni Research

Sam Stovall of CFRA Research reports that, since World War II, there have been 56 “pullbacks” (declines of 5% to 9.9%), 22 corrections (10% to 19.9% selloffs), and 12 bear markets. On average, pullbacks occur once a year, corrections every 2.8 years, and bear markets nearly every five years, he indicates. (Stocks recovered all their losses within two months of a pullback and four months after a correction, on average, he found.)

That’s where things get dicey. In only one year — 1990 — did the market have two 10%-plus corrections, and in retrospect that marked the beginning of the great 1990s bull. (The year 1997 had a 9.6% decline and a 10.8% drop, while 2011 registered a 9.8% pullback in addition to its 19.4% correction.)

But we’re in the opposite situation: The S&P 500 is already 9½ years into a bull market, making it by some measures the longest ever. It has risen 336% from its March 2009 low, making it the third biggest after the 1990s and 1920s super-bulls. How much longer can it go on and how much higher can it go?

I’m confident the U.S. economy will remain strong, though rising interest rates and a strong dollar are causing the blight in emerging markets to spread. As earnings season begins, we should see the third consecutive quarter of 20% year-over-year earnings gains for S&P 500 companies. And though President Trump may call the Federal Reserve “crazy” or “loco,” Jay Powell, the chairman he appointed, is only modestly stepping up the gradual pace of increases in the federal funds rate that his predecessor, Janet Yellen, instituted during her tenure.

But rising 10-year Treasury yields, the result of a much stronger economy, already are cutting into housing sales. If 10-year Treasurys yield in the high-3% or low-4% range (their yield is currently 3.16%), that might not kill the bull altogether, but they would begin to offer returns competitive to those of stocks.

Related video: Correction a silver lining in ongoing bull market, says pro (provided by CNBC)

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Meanwhile, the CBOE Volatility Index (VIX) , known as the VIX, has shot up above 20, its highest since April. The VIX is a pretty crude, flawed measure, but it reflects investors’ concerns that market risk is rising.

I still lean toward the belief this is yet another pullback or correction. But at some point, either a recession or financial panic will bring on a full-fledged bear. It’s very difficult to predict that in advance, so I’d suggest most people within 10 years of retirement stay in stocks to profit from future advances while taking some profits during rallies to reduce your equities position to no more than 50% of your total holdings.

Investors need to be prudent, not reckless, as risk rises and stocks have seemingly defied gravity to move higher and higher.

Howard R. Gold is a MarketWatch columnist and founder and editor of GoldenEgg Investing, which offers exclusive market commentary and simple, low-cost, low-risk retirement investing plans. Follow him on Twitter @howardrgold.

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