Corrections, recessions and crashes

If there's one thing the month of March 2020 has taught us, it's that the stock market doesn't go up in a straight line. Indeed, since its very inception, the equity market has experienced corrections, bear markets (often associated with recessions), and crashes. These events occur irregularly, but with some frequency, and, accordingly, it's important to understand the differences between them, what causes them, how long they last, and what typically follows each unique set of circumstances. Market corrections are generally categorized by a pullback of 10% or more from a recent high. They can be caused by any number of events, but usually occur when reality fails to live up to one or more short-term expectations. It could be that Gross Domestic Product (GDP) came in weaker than expected for one quarter, that changes to fiscal or monetary policy didn't go far enough to appease investors on a short-term basis, or that corporate earnings were lower than expected, causing stock prices to fall, as a mechanism for discounting slower growth. On average, these corrections occur every 8 to 12 months and tend to last anywhere from two to five months. Afterward, equity markets typically resume their upward trajectory, unless something more serious comes along to cause a bear market or, even worse, a crash. Bear markets usually refer to a 20% or more drop in stock prices and tend to be brought on by more problematic trends in the market, including a global political shock, significantly lower disposable income, weaker productivity, plummeting consumer confidence, rising default rates, or some other series of events that begin to instill fear in the market. When these situations arise, some investors begin to sell investments in an effort to escape future losses. This can amplify the so-called "fear trade," leading to higher volatility and worsening general market conditions. History teaches us this type of market timingthe "get me out now, get me back in later strategy"isn't effective over extended periods of time, but let's put that argument aside for now. The fact is bear markets have occurred approximately once every seven years or so since 1920 and, according to CFRA (Center for Financial Research and Analysis), have lasted an average of 14 months since World War II, and an average of 22 months since 1926. Following each bear market, equities tend to experience a significant recovery, in the form of bull markets that have generated cumulative returns of between 48% and 417% over a multi-year period. Crashes are usually described as an extreme bear market, where fear leads to panic, and panic leads to a significant decline over a very short period of time. Since the early 1900s, the stock market has really only "crashed" twice - once beginning in October 1929 (overconfidence, margin debt, and a steep increase in interest rates, ultimately leading to a short-term run on the banks), and again in October 1987 (disconnect between equity markets and derivative securities, lack of liquidity, anti-takeover legislation, etc.). We've certainly experienced other significant bear markets, such as those beginning in March 1937 (premature spending cuts during the Great Depression), January 1973 (price controls and the Arab oil embargo), March 2000 (bursting of the tech bubble) and October 2007 (financial crisis, leading to the Great Recession) but, in these instances, markets fell sharply over a much longer period of time. Most bear markets and recessions/crashes last for less than 20 months, and all have been followed by significant bull market runs. As of Friday, March 27, the S&P 500 Index was down 25% from its 52-week high, and the Dow Jones Industrial Average was down by nearly 27%, mostly due to the fear and panic caused by the coronavirus, a price war in oil being waged by Saudi Arabia, Russia and others, and the economic fallout the combination of these events will undoubtedly have on corporate earnings and society at large. Given the circumstances, and as amplified by today's algorithmic trading platforms that buy and sell stocks automatically if a particular index rises or falls to a specific level, things may, in fact, get worse before they get better. The speed at which markets have fallen over the past few weeks is unprecedented and is already being referred to as a crash. Remember, though, it's always darkest before the dawn, and this, too, shall pass. During times like these, it's imperative that investors don't succumb to the fear and panic that have overtaken so many. Act rationally, stay invested, and work with your advisor to use recent market events to your best advantage. Since the early 1900s and on an annual basis, the market has gone up approximately 73% of the time, and the ups have generally been much larger than the downsthis is what keeps us invested. Accept that corrections, recessions and crashes are a normal part of being an investor. Remember that the market goes up and down, but always with an upward bias. Keep your cool, maintain a long-term focus, and don't try to time the market. Your patience will ultimately be rewarded, just as it has so many other times in the past. ----- Stephen A. Rossi is senior vice president and senior equity strategist at Canandaigua National Bank & Trust. Published: Mon, Apr 06, 2020