ALBERT HERTER

‘STOCK MARKET CORRECTIONS: UNSETTLING BUT NOT UNUSUAL,’ by Dirk Hofschire, V. P. of Fidelity’s Market Analysis & Research, Fidelity Viewpoints.

In Uncategorized on May 21, 2010 at 16:03

Stock market corrections: Unsettling but not unusual

BY DIRK HOFSCHIRE, CFA, VICE PRESIDENT OF FIDELITY’S MARKET ANALYSIS, RESEARCH AND EDUCATION GROUP, FIDELITY VIEWPOINTS — 05/20/10

With U.S. stocks falling more than 10% from their April peak, the market has officially entered correction territory for the first time since the cyclical bull market began in March 2009.

The Greek debt crisis and flagging confidence in Europe more generally have been the catalysts that punctured investor confidence. Europe is staring at the prospect of either further financial instability or at best a period of severe fiscal austerity that will likely serve to depress economic growth.

Either way, Europe’s turn for the worse has caused most analysts to ratchet down their expectations for global growth in 2010.

Outside Europe there also is plenty to worry about. The developing world has grown at a fast clip, but it is now facing rising inflation and is reining in stimulus policies. China, India and Brazil have all moved to tighten lending or raise interest rates. While U.S. policymakers are not expected to raise rates anytime soon, there have been plenty of unsettling headlines, from uncertainty about the impact of the crude-oil spill in the Gulf of Mexico to the details of financial sector reform legislation.

Whether this confluence of events will continue to drive the market lower in the near term is impossible to know, but there are two things investors may want to keep in mind.

First, the global economy went into this period of financial market volatility in much better shape than in early 2009. The strength of the economic recovery during the past year, particularly in the United States and Asia, has continually surprised on the upside. While that momentum will undoubtedly slow, it does not automatically mean a reversal back to global recession.

Second, while the stock market correction so far has been abrupt and painful, it has actually been relatively typical of what might have been expected to happen given historical patterns. Consider:

Timing of correction was typical. It’s been about 14 months since the current bull market began on March 9, 2009, which is in the neighborhood of the average length of time that has passed from the start of prior bull markets to a first correction (17 months, see table).

Early bull market’s gains were above average. The stock market gained 80% before the recent correction. Historically, the first correction in a bull market has come after average gains of 57%, implying the current bull market was overdue for a correction on a price appreciation basis.

Correction pace fairly quick. The main factor that has differentiated this recent correction is that it has taken place at a fairly swift pace compared to history. It took 24 days for the market to surpass the 10% decline threshold, which is about half the time it has historically taken on average for a correction to occur (54 days).

Investment implications

Since 1926, there have been 20 stock market corrections during bull markets, meaning 20 times the market declined 10% but did not subsequently fall into bear market territory. Whether the market recovers again from here and avoids a bear market remains to be seen, but at the very least the more surprising development based on historical patterns would have been a continued bull market rally without a 10% pause.

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