Stock Market Corrections: 3 Things We Don't Know, and the Only Number That Matters – Motley Fool

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Disneyland theme park tickets getting too expensive? Don’t worry — you have the stock market, which has seemingly offered its own variety of roller coaster-like dips and jumps over the past two months.

OK, perhaps that’s a bit facetious, but the volatility in the stock market’s major indexes — the iconic Dow Jones Industrial Average (DJINDICES:^DJI) and broad-based S&P 500 (SNPINDEX:^GSPC) — since February is certainly unsettling to investors. Through Tuesday, March 27, the Dow had logged four of its nine largest single-day point declines in a matter of two months. This includes a 1,175-point drop on Feb. 5, marking its largest single-day point move lower in nearly 122 years. It also sent the CBOE Volatility Index briefly to highs not seen since the Great Recession in 2009.  

Image source: Getty Images.

Both the Dow and S&P 500 officially entered into “correction territory” — i.e., a drop of at least 10% from recent highs — as of February, marking the first time these indexes have been in correction since early 2016. And as you might have expected, the mere mention of “stock market correction” is causing panic attacks and increased volatility with short-sighted investors.

Three things we’ll never know about corrections

In order to understand how best to deal with a stock market correction as a long-term investor, it’s important to first recognize what we’ll never know about corrections.

1. When they’ll occur

First of all, there’s no way investors can predict with any long-term consistency when a stock market correction will occur. Even though there have been 36 corrections of at least 10%, when rounded, in the S&P 500 since 1950, which works out to one every roughly two years, trying to pinpoint when a correction will decisively occur is nothing more than a crap shoot. Last year, numerous Wall Street pundits called for a correction, and nothing more than a few percentage-point drop was seen all year. In short, corrections are inevitable, but we don’t exactly know when they’re going to rear their head.

Image source: Getty Images.

2. How far the stock market will dip, and how long it’ll take

Second, it’s absolutely impossible to know just how far the stock market will fall, as well as how long it’ll take to reach its trough.

As recently noted, more than 70% of stock market corrections over the past 50 years have lasted less than 104 days (roughly three and a half months), while around 20% tend to last beyond 500 days. Which variety of correction will we get next? No one knows with any certainty. The odds suggest that most corrections tend to be swift, but that’s not always going to be the case. A bear market correction (a drop of 20% or more from a recent high) tends to occur about once a decade, on average, and we haven’t seen one in nine years. Though the stock market doesn’t strictly adhere to averages, it’s something to be aware of. 

3. What causes them

Finally, we’re never going to know ahead of time what causes stock market corrections. Though there will be no shortage of pundits explaining why “X” is going to lead the market lower, there’s often some X-factor that comes into play, which few people saw, pushing stocks lower.

For instance, Facebook‘s data privacy concerns have caused a recent wreck in the technology sector, weighing on the Nasdaq Composite and its fellow tech peers. Until recently, technology was a leading sector. Now, it could be the catalyst that leads the stock market lower. X-factors are everywhere, and we just can’t recognize them with any consistency ahead of time.

Image source: Getty Images.

The only stock market correction figure that matters

However, hindsight is 20-20, and stock market correction data unequivocally shows that buying during corrections of any size is a smart idea.

Over those aforementioned 36 corrections since 1950, all but one, the current correction, has been completely erased by a bull market or extended rally. This essentially means that if you have a long-term outlook, your aggregate investable nest egg should increase in value over time. Keep in mind that this doesn’t mean you’ll be right on every stock you buy. Some of the best stock pickers in the world are only right about 60% of the time. But the key point being that if you buy high-quality companies and ride the winners for a long period of time, their compounding gains will make you a winner.

There’s simply no need to fear a correction, even if we know virtually nothing about them ahead of time.

Sean Williams has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Facebook. The Motley Fool has a disclosure policy.

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