The Nature of This Correction

06/09/2010 1:00 pm EST

Focus: MARKETS

Janet Brown

Editor, NoLoad Fund*X

Janet Brown, editor of NoLoad Fund*X, says this correction is very typical of many that we’ve had in the past, and reminds us that earnings are the best they’ve been in years.

We have now officially had a correction, as all major indexes declined more than 10% from recent peaks. This is the first true correction since the March 2009 low, from which the [Standard & Poor’s] 500 is still up 60%.

Stock declines are part of normal market action. Since 1926, there have been 20 stock market corrections during bull markets, meaning 20 times the market declined 10% but did not subsequently fall into bear market territory.

No one knows if the correction is near completion, or if the powerful bull market that began in March 2009 will give way to a new bear market. But we do know, based on historical patterns, that a bull market rally of this magnitude without a 10% pause would be unusual.

Recent market extremes show us how unpredictable markets are. Yet, when we look at historical market cycles we see that this correction has been fairly typical. Since the 1920s, pullbacks have tended to come around this point in a market cycle and have averaged 12%.

It’s been about 14 months since the current bull market began on March 9, 2009, which is not too far off the historical average of 17 months [from] the start of a bull market to its first correction.

The stock market gained 80% before the recent correction. Historically, the first correction in a new bull market has come after average gains of 57%, implying the current bull market was overdue for a correction.

The distinguishing factor of this recent correction is that it occurred quickly compared to previous corrections. It took just 27 days for the market to surpass the 10% decline threshold, which is half the average time.

Certainly, the debt crisis in Europe is worrisome, primarily because another shock to global financial institutions would have a significant impact on investor psychology. The fundamental economic impact on the US may not be great, however, since Greece, Spain, and Portugal together account for less than 1% of US exports.

First-quarter earnings were quite good—rising 31% over the same period last year, the most since 1984 and more than 15% above analysts’ expectations. All ten sectors of the S&P 500 posted year-over-year profit and sales growth. As a whole, the S&P 500 is beating estimates at the greatest rate since 1987 when such data was first tracked.

2010 has been a volatile year so far, but market leadership trends have been consistent. We have been rapidly reducing exposure to foreign funds all year, and as of this month, our core holdings are 100% domestic. The larger trend of mid-cap and small-cap funds outperforming larger-cap funds seems intact, even though on the downside in May small-caps lost a bit more than large caps. Both small- and mid-cap funds have far outpaced large caps from the market bottom in March 2009.

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