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CLS: Time to Get Nervous?

02/04/2014

Does that fact that January was the worst month for the stock market since May 2012 mean this is the start of a market correction? Should we be nervous?  The short answer is “no.”

Most likely, this recent pullback is not going to develop into a correction, nor a bear market.  Second, even if it does turn into a correction (or a bear market), remember this is just normal market behavior. Corrections happen.

For many investors, it’s best to consider a potential correction as a step back before the market’s eventual next two steps forward. In addition, for long-term investors, market volatility often provides opportunities to enhance future returns.

If, however, a potential temporary loss of 20 percent, or more, would impede your ability to achieve your financial objectives, then by all means revisit your long-term plan and review your risk tolerance with your advisor. If a move to a lower risk budget is in order, please make sure it is done for appropriate reasons and not simply to try to time the market.

This all said, it does seem extraordinary how much excitement there is over this recent market pullback. However, as of month-end, the market (at least defined by the imperfect S&P 500) is only about 4 percent off its all-time intra-day highs from January 15. Then again, the market has had a nice run and it shouldn’t be too surprising to see some investors a bit agitated, particularly if they recently increased their stock market holdings.

What hasn’t been normal is the price action over the last year, or more. Despite strong price gains, overall price volatility has been extremely low by historical measures. In addition, the market has been long overdue for a pause to refresh. In fact, the market hasn’t even fallen 5 percent from its prior highs since May 2013, and 10 percent from its prior highs since mid-2011 (its fifth longest stretch in history without a correction).   We haven’t seen a bear market since the last one ended in March 2009 – nearly five years ago.

For some perspective, let’s look at how corrections and bear markets are defined, and how often do they occur.
First, a “correction” is defined as a loss of 10 percent or more. Since 1945, there have only been 27 corrections, or about one every two and half years. Again, it hasn’t yet been two years since the last correction.

A bear market, meanwhile, is defined as a loss of 20 percent or more. Since 1945, there have been 12 bear markets, or about one every five and a half years. Again, the last bear market was nearly five years ago.

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