What is a stock market correction, and how is it different from a bear market?
Stocks around the world sold off today, fueled by growing coronavirus concern and plummeting oil prices. Trading even briefly halted this morning as the result of a 7% drop that triggered a circuit breaker in place for extreme volatility. Due to these wild fluctuations over the last couple of weeks, you’ve probably seen headlines throwing around some scary words, like “stock market correction,” “bear market,” and “recession.” So, I wanted to quickly break down what each of these terms actually means and offer some commentary on the current market situation.
What is a Correction?
A correction is classically defined as being down 10%+ from recent highs. Over the past couple of weeks, U.S. Stocks did indeed drop into correction territory. Corrections are typically shorter-term but can sometimes take months to rebound fully.
What is a Bear Market?
A bear market is classically defined as a 20% drop from recent highs. The last time we neared bear market territory was around Christmas of 2018 during the government shutdown. Since then, stocks have rebounded and even hit new highs. As we once again test bear market territory in U.S. stocks, it is important to point out that a bear market does not always lead to a recession.
What is a Recession?
An economic recession is typically defined as two consecutive quarters of declines in quarterly real (inflation adjusted) gross domestic product (GDP). Market corrections or even bear markets can happen without an economic recession — they are not synonymous. A bear market without a recession tends to be shallower in nature compared to a bear market with a recession, which tends to be more severe.
Our Take on Recent Market Volatility
Coronavirus has sent shockwaves through the markets, with the Dow recording its worst day ever, before shooting back up after Super Tuesday, and then crashing back down again. This rollercoaster can really have an impact on our emotions – it’s not easy to see major negative fluctuations in our portfolios! But while this might be a scary time for investors, it’s important to try not to make knee-jerk reactions that might jeopardize your long-term goals. Selling during major panics like what’s happening now will lock in your losses, so we urge you to talk to your financial advisor if you’re worried or unsure about what to do in the current market environment.
While I wish I could tell you that things will get better soon, there’s no way to know if we’re near the bottom and that this is simply a repeat of December 2018 and February 2016, or if there’s more heavy selling to come before an eventual rebound. We also can’t say whether current headwinds will lead to a recession or if this is the beginning of a larger secular shift. The truth is, no one actually knows. It’s only possible to identify these things in hindsight. It is starting to look more likely that U.S. stocks might enter a bear market with major indices now trading very close to a 20% drop (but remember, a bear market and recession are not synonymous). It’s also likely that the U.S. government will introduce aggressive new policies to help businesses and individuals weather the impact.
Looking at the current environment, the coronavirus has emerged as a “black swan event,” which is something that was unforeseeable with a potential major impact. It emerged against a backdrop of solid U.S. economic data and the momentum of a bull-market, but still fragile global economy. If you add in the risks of increased globalization, a pricing war in oil, all-time low interest rates, and an election year, it’s no wonder markets have been jittery.
The bottom line is that there’s no way to know when this sell-off will find a bottom. With so many factors at play, the markets may continue to be volatile, which means you should expect movement to both the upside and downside. Big up days tend to take place when markets are falling, making them impossible to time and potentially detrimental to your portfolio if you miss them. We usually recommend staying invested and making sure you’re in the appropriate portfolio allocation.
Should I Make Any Changes to My Portfolio?
Even if U.S. stocks enter bear market territory, we don’t see anything suggesting that the fundamental reasons for owning stocks have changed. Regardless of what happens in the coming weeks or months, ups and downs are both part of a natural market cycles. Your financial advisor should have you in a portfolio that will take that fact into account and balance it with your personal risk tolerance, time horizon, and goals.
So, what do we do at Personal Capital to help our clients through the ups and downs of the market? The most important thing we do for our clients is help them build a thoughtful, data-driven financial plan. Part of this process means identifying an appropriate asset allocation that clients can stick with through full market cycles. We then help execute the plan by implementing personalized investment strategies focused on better diversification with the optimal amount of portfolio risk, which will be unique for everyone. This is based on level of risk tolerance, time horizon, and personal financial goals. We maintain efficient portfolios that are strategically designed around growth and cash flow goals. We seek to avoid market timing, maintain disciplined allocations, and are ruthless about tax optimization. Why? We think this provides the best chance for successful outcomes over the long term, even when there are bumps in the road or periods of downward volatility. We also do some strategic tax-loss harvesting where applicable to offset taxable gains in a portfolio.
But long-term focused or not, it’s natural to feel worried in down market periods. If the last few weeks have made you realize that you over-estimated your risk tolerance or need a more holistic investment approach, it’s still a great time to adjust to the right, properly diversified strategy.