It seems like only yesterday that millennials were sharing their 401(k) accounts online, telling the world they were millionaires on paper. Well, it was almost yesterday. Last week, to be exact.
And what a week it has been.
Some saw it coming. They said the stock market was long overdue a reality check, or two. Others felt like the bull market could go on and on. After a week of nerve-wracking volatility, the Dow Jones Industrial Average DJIA, -4.15% fell more than 1,000 points Thursday, or 4.15%, extending its recent selloff to more than 10%. That means the Dow is now officially in correction territory.
A correction, in theory, could extend to 19%. Beyond 20% and we’re officially in a bear market. That’s around the time when millennials start wondering what it means for them and, perhaps worse, their parents and grandparents. Stock market corrections and downturns are typically of more interest to people who are retired — and those drawing on their savings for income have cause to worry.
Also see: 5 great questions Americans are asking about the market’s crazy ride
President Trump has taken in pride in the bullish stock market since winning the presidential election. In 2018, generous tax cuts for U.S. corporations further propelled stocks. But bearish investors were also worried about inflation and rising bond yields and, after the recent downward spiral, some on Twitter TWTR, +12.15% wondered, “How low can the market go?”
It’s a good question, if not an altogether simple one. Here are a few things to bear in mind:
The Dow could fall 15% in total (or more)
“Correction territory doesn’t mean we’ll see an immediate rebound,” said Greg McBride, chief financial analyst at Bankrate.com. “A total decline of 15% wouldn’t be out of the ordinary and would send a very clear buy signal.” Currently, more than 10% of S&P 500 stocks are in a bear market, but McBride said he’d be surprised to see the S&P 500 fall more than 20%.
Investors are choosing fear or fundamentals
The extent of the drop depends on whether people focus on fear or fundamentals, said Kyle Woodley, senior investing editor at Kiplinger.com. “It could keep going on sheer fear, but then the smart money comes in and buys value. There’s a fundamentally strong economy and employment is good. This 1,000-point drop comes in the middle of a really impressive earnings season.”
The worst-case scenario (or one of them)
At what point do people start looking at the economic backdrop and ask if this correction was needed or overdone? “The worst-case scenario is that it breaks below the 200-day moving average,” Woodley said. “The last time it broke that was mid-2008,” he said, “but that was a bear market driven by a financial collapse. It stayed there until it broke back in 2010, tested it in 2011 and again in 2016.”
A market correction scares off speculators
It will allow investors to recalibrate after a heady few months, McBride said. “People have been chasing the market because interest rates have been so low,” he said. “Stocks have been the only place to go for any sort of yield or return. A correction shakes out the speculators and the real investors come in and buy, establishing the floor and setting the stage for the next advance.”
Corrections tend to have a short shelf life
Corrections produced an average decline of 13.3% over 71.6 trading days, according to an analysis of the Dow between 1945 and 2013 by John Prestbo, a retired editor and executive director of Dow Jones Indexes, now part of S&P Dow Jones Indices. Since 2000, he found that the average correction has had a decline of approximately 14% and they average around one per year.
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Historically, recent market crashes are very small
Context is everything. The Dow plummeted 90% in the Great Depression versus 54% in the Great Recession. In the 1930s, the “gold standard” meant the government could not stimulate the economy by increasing the amount of money in circulation without increasing the gold reserves. Given that it took the Dow six years to recover the last time, this correction pales in comparison.
For long-term investors, the news remains good
“Historically, the market has trended upward,” according to Prestbo. “Occasionally, such as during the 1950s and 1990s, the gains are strong and persistent. More often the market meanders, taking one step down for every two it moves up.” But buckle up for a bumpy ride, if you are a new investor in 2018. “Pullbacks of less than 5% were so common,” he said, “I gave up counting them.”