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 patternrn? Are crashes typically preceded by low-volatility years without meaningful corrections?

Unfortunately, I found very little consistency in these patternrns 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:

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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:

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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:

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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 patternrn. 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.