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Market Correction

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Def.: Correction (noun) 1) something that is substituted or proposed for what is wrong or inaccurate.    

US stocks fell nearly 6% last week, the market's worst week since 2011, and this morning started in the same direction.  From its high in May, the market is now down more than 10%, qualifying this pullback as a "correction".  The media has been shrill in its commentary (one USA Today headline blared "Dow Dives into Bloodbath").  

What should be made of this?  First, while a 10% market give back may feel unusual and may be reported as unusual, in truth, such moves have historically occurred nearly once per year.  The only thing unusual here is that there has not been one in nearly four years.  

Second, it's important to remember that the market is still up nearly 200% in the past five years after last week’s decline.  

So, what does this decline mean about the future?  Unfortunately, not nearly as much many would have you believe.  Consider: 5% market drops have occurred on average about three times per year in the past, but only a little over one in three of those have continued on to become a 10% down move or more.  10% market corrections have occurred nearly once a year historically, but only about one in three of those went on to become a 20% or more decline (i.e., “bear market”).  And 20% market declines have occurred about every 3-4 years on average historically but only a few of those have ever turned into 40% or more declines.   

We have expressed concern about market valuations for some time, and the current market correction is just that: a correction of a prior mistake.  The market has suddenly determined that some of the recent market gains were unwarranted and has repriced stocks downward.  That’s OK.  It’s what markets do from time to time.  

Stocks are appropriate as long term investments, offering better long term returns than bonds or cash in exchange for much more short term volatility.  Short term volatility is the natural state of the market, and its near absence in recent years has been unusual.  Long term goals are best served by ignoring short term volatility.  We have no idea whether the current market slide will continue for a while or turn up from here.  We just know that stock returns are highly likely to exceed bond returns in the long run, and that periodic rebalancing offers a way to make short term volatility work in your favor.