A Study of Stock-Market Corrections

The stock market gave very few scares last year. Ending the year up 30% was impressive. Yet, the absence of any meaningful correction was even more impressive… or worrisome… depending on your perspective.

While stock investors naturally enjoyed the “no cold” season last year… pullbacks, corrections, bear markets, and utter busts are a natural phenomenon of free markets.

The absence of a meaningful correction last year has led some to assume we’re more than due for a nasty sell-off this year, as if to even the score. Hearing this a lot lately, I began looking closely at recent market crashes, attempting to answer the questions: Is there a pattern? Are crashes typically preceded by low-volatility years without meaningful corrections?

Unfortunately, I found very little consistency in these patterns when I looked at the 2000 and 2007 market crashes.

Here’s a chart showing all the pullbacks (corrections) the S&P 500 underwent during the four years leading up to 2000:

See larger image

As you can see, there were at least six separate pullbacks of 10% or more and one correction of more than 15%. This shows that the market can crash, even after several years in which small, but frequent pullbacks restored the market’s natural equilibrium.

Next was the crash of 2007 to 2008. Here’s a chart showing the pullbacks in the S&P 500 from 2004 to 2008:

See larger image

In contrast to the 2000 crash, the 2007 to 2008 crash was preceded by four years that lacked a correction of 15% or more. That said, there were frequent pullbacks of nearly 10% between 2004 and 2008.

Finally, here’s a chart showing the S&P 500’s pullbacks since 2010:

See larger image

Of note, we saw a 15% correction in 2010 and another one, this time nearly 20%, in 2011. 2012 was calmer, experiencing just two pullbacks of about 10%. And then 2013 was exceptionally smooth, with a small handful of mild, 5% pullbacks.

So, how do we interpret these findings?

Well, sadly, there’s no clear trend or pattern. This research shows loosely that market crashes can occur almost at any time, even after periods when frequent corrections should have restored the market’s equilibrium (and thus prevented a sudden, market-jarring crash).

This means we’ll continue to stand on guard, watching for the potential of a more volatile year than last. At the same time, we’ll continue to invest accordingly alongside a strong bull market that hasn’t ended quite yet.

What Killed the Middle Class?

Today real incomes of the middle class are 5% lower than they were in 1970 and 12.4% lower than in 2000… when they peaked! How could this be?

In our new infographic What Killed the Middle Class?, we take a look at some shocking numbers to show how bad it’s become and what has been fueling this middle-class revolt.

 

LEARN MORE
Categories: Cycles

About Author

Adam O'Dell has one purpose in mind: to find and bring to subscribers investment opportunities that return the maximum profit with the minimum risk. Adam has worked as a Prop Trader for a spot Forex firm. While there, he learned the fundamentals of trading in the world’s largest market. He excelled at trading the volatile currency markets by seeking out low-risk entry points for trades with high profit potential. An MBA graduate and Affiliate Member of the Market Technicians Association, Adam is a lifelong student of the markets. He is editor of our hugely successful trading service, Cycle 9 Alert.