3 things you should know about market corrections

It’s been nearly two weeks since U.S. stocks thudded their way into a “correction” — a drop of at least 10 percent from their peak — leaving rattled investors wondering if a bear market decline of 20 percent or more might be around the corner. 

It’s no wonder the drop jangled nerves, with the selloff the first correction on Wall Street in 500 days. But a little historical context is helpful in putting the decline in perspective.

Corrections aren’t collapses

Most market corrections occur when the economy isn’t recession — indeed, bear markets rarely follow. That’s according to strategists at Goldman Sachs, who note positive returns three, six and 12 months after a 10 percent drop, and that’s even if the S&P 500 (SPX) falls more than that. 

John Lynch, chief investment strategist at LPL Financial, says a look back at how the market has performed since 1980 reinforces “the necessity for long-term investors not to stray from their diversified strategies during periods of market turmoil.” 

In that time, Wall Street has endured 37 corrections, falling an average of 15.6 percent from peak to trough during the last 36 of those declines. A year later, the S&P 500 made up the last ground, and after 24 months had climbed an average of 28 percent.

Follow the money

Some observers view the stock market as an indicator of what’s to come roughly six months down the road. But most economists don’t see a market-derailing recession this year, with Goldman pointing to the high levels of consumer and business confidence. 

Lynch also notes that recent corporate earnings are beating expectations, while companies are forecasting healthy profits this year. That’s not what you’d expect to see if a storm in financial markets threatened to capsize the broader economy.

So what should investors do? 

Goldman recommends looking at cyclical stocks, meaning consumer discretionary companies that tend to thrive when the economy is doing well and people are spending more freely. Such stocks tend to rebound the most three months after a correction. The banking giant also advises investing in companies that routinely funnel cash from operations into research and development, as they are investing in future growth. 

“Our first piece of advice for investors is don’t panic,” added LPL’s Lynch, who said in a note that the correction offers the chance to reassess portfolios and “look for spots to either deploy cash or rebalance to longer-term allocation targets.”

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