Differentiating A Bear Market From A Market Correction
In the jargon of financial markets a “correction” in a stock index is defined as a fall of 10 per cent and a “bear market” is a fall of 20 per cent. This correction is measured from the most recent peak in the market.
Corrections are relatively common but bear markets generally only occur in a recession. For the Australian market there has been an intra-year fall of 10 per cent or more in 21 of the last 28 years.
In 13 of those years, the ASX 200 still finished higher for the year.
The United States has seen a slightly smaller number of corrections. There have been 12 corrections in the US in the past 22 years. The typical correction is around 15 per cent and lasts for 58 trading days.
In most cases they have returned to previous levels reasonably quickly.
Causes of corrections
Corrections have a range of causes. They can often reflect over-reactions to events such as political or macroeconomic events, and markets tend to recover once it becomes clear that the impact of the event is not going to be significant.
Generally a correction has not become a bear market unless there has been a recession. The three US bear markets of the past 20 years correspond to the three recessions during that period i.e.,
- The 2001-03 recession
- The global financial crisis (GFC)
- The COVID-19 crisis.
In considering whether the current selloff will become a “bear market”, and the severity of that bear market, the main question is the possibility of recession. To assess this we consider such issues as:
- the implications of rising interest rates,
- the prospects for financial system stress, given debt levels have increased in recent years.
Tips for navigating a bear market
While market corrections and bear markets can be distressing for investors, often the worst mistake that investors can make is selling stocks after a big fall. This increases the chance of a permanent loss of capital.
Even during the GFC, investors who stayed the course i.e. retained their equity holdings, recouped their losses within a few years. Additionally, investors who sold out of their holdings after the collapse of Lehman Brothers would not have been able to recoup those losses in other asset classes.
As always, stay close to your adviser.
This document was prepared by Evans and Partners Pty Ltd (ABN 85 125 338 785, AFSL 318075) (“Evans and Partners”). Evans and Partners is a wholly owned subsidiaries of E&P Financial Group Limited (ABN 54 60 9913 457) (E&P Financial Group) and related bodies corporate.
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