After a year of record low volatility in 2017, volatility has returned to the U.S. stock market. The S&P 500 index (the stock market “index”) increased 7.5% in the first 18 trading days of the year until reaching its peak level on January 26th. In only 9 trading days after the January 26th peak, the index had decreased 10.2% by February 8th. The index's 10% decline from its peak is what is commonly referred to as a correction. Declines of greater than 10% are common occurrences with stocks (or any liquid asset class that has a degree of risk). Prior to this occurrence, there have been 27 market corrections since 1967. That would mean that corrections occur on average every 2 years. Of these 27 corrections, 18 ended before dropping more than 20% and falling into bear market territory.   

It is important to reiterate that 10-20% declines are a common occurrence. In a climate such as this, many investors begin to wonder if this is the start of a bear market. My answer in this case is no. Historically, the stock market has not dropped more than 20% without being preceded by an inverted yield curve and subsequent recession. Currently there is no yield curve inversion to signal a recession, and economic GDP growth in the current quarter and looking out one quarter looks robust (at least 2.5% annualized). From a valuation perspective, the stock market is not severely overvalued. Currently the index P/E ratio is 24, which is in line with where it has historically traded. In fact, during the late 1990’s (1995-2000) when the index earnings were growing a robust 12-20% annually the index P/E ratio was consistently above 30 and spent significant time in the 35-50x range. As such, valuation is not going to be a particularly useful guide to tell the future direction of the market in the short term.   

U.S. stock market corrections defined as S&P index drops of greater than 10% but less than 20% are shown in the table below. These occurrences are significantly more (twice as) frequent and shorter in duration than bear markets (defined as index declines of greater than 20%). There are few if any preceding warning signs to stock market corrections, and I believe it is futile to attempt to avoid these as they are a normal function of investing in stocks (or any asset with a degree of risk). 

My advice to any investor concerned about the stock market gyrations is not to worry and avoid closely following the short-term market fluctuations. Over the long-term (5+ years) the stock market, and subsequently your account value, will be higher than it is today. Unless you need to liquidate the stocks in your account within the next 1-2 years (in which case you should not be invested in stocks anyway), the daily, monthly or quarterly movements of the stock market are essentially meaningless. Market corrections should be viewed as a buying opportunity. If you are a savvy person who has been holding excess cash, you should use declines to your advantage. By adding to your stock allocations during a correction, a buyer will be rewarded handsomely when it seems that everyone else is selling.