The recent fall in stock markets had investors buzzing. The terms “correction” and “bear market” were being flung around as freely as beer at Oktoberfest. The burning question on everyone's minds? "Should we view this sudden drop in global market performance as a correction; or is there a bear market on the horizon?"
As value investors, we are not easily shaken by hype and media. We take a calm approach and turn to the facts to guide us, most especially when it seems like everyone else is in a frenzy. So let’s do that now and look at what distinguishes a correction from a bear market.
Breaking Down a Bear Market
1. What is a bear market?
A bear market is typically characterised by a downturn of 20% or more, lasting at least sixty days, in any broad equity index such as the Dow Jones Industrial Average, the S&P 500 or the Nasdaq.
2. How is a bear market triggered?
Generally speaking, a bear market is triggered when investors lose faith in the market as a whole, resulting in a decreased demand for stocks. This tends to happen when the economy enters a recession, or when unemployment is high and rising.
3. Bear markets are difficult to predict
The stock market has a way of its own, which no one can accurately predict. The only thing to do is to prepare for various conditions, including a bear market. Statistically speaking, the U.S. stock market has experienced 25 bear markets since 1929, giving an average one every 3.4 years. Considering the last bear market ended in March 2009, we are technically overdue by roughly 3 years.
4. How long do bear markets last?
As with most financial movements, bear markets won’t last eternally. Looking back to the 25 bear markets that have occurred, they lasted, on average, for 10 months each. From a value investor’s perspective, this is merely a blip on an investment timeline.
5. They can be mild or quite harsh
The average bear market loss is 35%, with the smallest loss being 21% in 1949 and the worst loss a drop of 62% from November 1931 to June 1932.
4 Facts About a Correction
1. What is a correction
Corrections are temporary price declines that interrupt an uptrend in the market. It is a reverse movement of at least 10% from a recent high. If a 20% downturn lasts less than two months, it is considered to be a correction as opposed to a bear market.
2. Why do corrections happen?
Stock price movements are similar to the law of physics, what goes up must come down. Corrections take place when stocks, bonds, commodities or indexes are overvalued or overbought. There is nothing you as an investor can do to avoid a correction from occurring as it is an inevitable part of stock ownership.
3. How long do corrections last?
Corrections happen fairly often, but rarely last long. According to research conducted by John Prestbo, at MarketWatch, on the Dow Jones Industrial Average between 1945 and 2013, the average correction lasts 71.6 trading days. But generally speaking, you could be looking at a few weeks to two quarters at most.
4. What are the effects of a correction?
A correction isn’t nearly as harsh as a bear market. Yes, it is still a drop of at least 10% in share price, but it is necessary to stabilise the markets and circumvent a complete market crash. The losses of a correction usually recover quickly, as the markets start growing again.
So are we heading for a bear market or was the sudden market drop merely a correction? Fortunately, we were only facing a well-needed correction. And a very short one too. The Dow Jones has already bounced back with an approximate 800-point rally over the last week. The S&P and Nasdaq both also posted gains above 2%.