The stock market has declined 5-10% 77 times in the last 70 years according to Ned Davis Research. On average, it has taken one month to recover from these levels. Market pullbacks happen, in normal times, with regular frequency. We have been in abnormal times as the economy has gained firm footing and picked up speed, while interest rates remained very low due to Federal Reserve policy. The recent pullback and spike in volatility has occurred as jobs numbers improved, wages are rising, and global inflation has shown signs of picking up. The best course during these periods is to rebalance, reduce risk, and diversify.
Over a normal market cycle there are four phases of market psychology.
- Good News is Good News. Economy is booming and markets cheer the positive momentum.
- Good News is Bad News. Late cycle. Incremental good news signals the party is almost over.
- Bad New is Bad News. During recessions the unwinding of exuberance leads to a bottom.
- Bad News is Good News. The markets react positively to incremental bad news. Recovery begins.
Corporate earnings have accelerated and global economies are picking up momentum. Interest rates will naturally rise to reflect this strength. It is also quite natural that volatility can pick up as this occurs. The global economy is on firm ground, but jobs reports can be very volatile. A single report is rarely predictive. Interest rates have eased since last week, which may signal that inflation is not a major factor yet. That said, we may be entering a period of Good News is Bad News.
Deeper declines do take longer to recover. Ned Davis Research found that a 10-20% decline took, on average, four months to recover in the post war era. Don’t get caught up in the headlines. Focus on the percentage moves, not the absolute numbers. A 508 point decline was over 22% of the DJIA in 1987. Monday’s 1175 point decline was less than 5%. Pullbacks and corrections are healthy for our economy and financial markets.