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Historical Look at Corrections

07/27/2017 2:56 am EST

Focus: STOCKS

James Stack

President, Stack Financial Management

The positive economic evidence and key technical indicators continue to support the outlook for further bull market gains; however, that does not rule out the possibility of a 5-10% correction in the months ahead, notes money manager and market historian, Jim Stack of InvesTech Research.

Corrections are a natural part of every bull market, and even in the current one there have been 14 declines of greater than 5%; these are shown in the graph below. These downturns have helped to rein in expectations and prevent investors from becoming overly enthusiastic.

chart 1

At this point, history suggests that the market is overdue for a pullback of 5% or more. As shown in the table below, corrections occur with regular frequency over the course of all bull markets.

On average, a 5% correction occurs about every 7.2 months and a 10% correction might be expected at least once every 26.1 months.

The current "correction-less" period is by far the longest of this bull market at 17.2 months. There was a 4.8% decline that ended prior to the election in 2016, but even if it had surpassed the 5% threshold, the market would already be due for another one.

chart 2

It also seems likely that a correction could occur within this seasonally weaker May-October period. Despite the impressive duration and gain of this current bull market, a 5% drawdown has occurred between May and October in every calendar year.

In several of those years (2010, 2011, and 2016), this 5% decline occurred within a larger correction that began before May, but in all eight years the S&P 500 experienced a loss of at least 5% at some point during the weaker seasonal time frame. Odds are that this year will be no different.

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