BUT We May Not Have Bottomed Yet

It’s true that there are five reasons that the correction will soon likely end and we’ll likely see a nice strong rally by the end of the year. However, we have to keep in mind market history as well. While never a 100% accurate forecaster, market history can provide a rough guide of what average downturns do. For example, historically when stocks fall 8% or more during October, the last two days of the month see a strong rally (average 2.8%). That’s exactly what’s happening this October with Tuesday’s 1.6% rally, followed by a 1.3% rally on Wednesday (at least as I’m writing this).

So what does market history have to say about corrections that occur in a healthy economy (what we have now)? Well according to Ben Carlson, director of institutional asset management at Ritholtz Wealth Management since 1928 the average correction that didn’t result in a bear market lasted 132 days and saw stocks decline a peak of 14%.

This correction saw stocks hit exactly 10%, which indicates that at least historically speaking, we might still be 4% from the eventual bottom. That’s because corrections usually end after what’s called “washout” days. That’s when the market falls hard one final time, washing out all the weaker investors who capitulate and sell in a blind panic. That’s what causes valuations to fall so low that bargain hunters step in and the market begins its average four-month recovery to fresh all-time highs.

While we’ve seen a drop as large as 3.1% in the S&P 500 this correction, thus far it doesn’t appear we’ve had a washout day. So does that mean that investors should be using this recent small recovery rally to sell and then wait to get back in 4% cheaper? Not necessarily. For one thing, historical analysis is only a very rough guide. Every correction is different and we can’t know exactly how far or how long stocks will fall this time.

What’s more according to Deutsche Bank starting on Monday, November 5th, about $14 billion per week of buybacks are likely coming that could very well put a floor under the market. In addition since 1950, the market has usually rallied 9% to the end of the year following a midterm election (Tuesday, November 6th).

In other words, this correction, just like the last one (also 10% decline) might end up being milder than the historical average, or it might not. So what should investors be doing when faced with such uncertainty?

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