On Monday, we saw a sell-off of more than 1 percent across major U.S. markets. Europe and Asia followed suit the next day. Judging by the e-mails I received, this was it, the beginning of the end, and "you unrepentant bulls are finally going to get what you deserved."
Except not quite yet. Tuesday and yesterday markets put in back-to-back rallies that erased the losses, and then some.
We have been discussing related themes -- hated rallies, the Fed & quantitative easing, and under-invested managers -- for quite some time. But rather than rely on what can only be described as unreliable anecdotal evidence, let's look into the data on corrections and crashes.
My colleague Josh Brown looked at the history of market crashes in the U.S. He notes that the Dow Jones Industrial Average has had 11 crashes of 35 percent or worse since it was formed in 1896:
The most benign of these eleven crashes took place between January of 2000 and October of 2002. It lasted for 999 days and lopped off 37.8% of the Dow's price, ending that fall at around 7286. The damage in the tech-heavy Nasdaq was obviously much worse but, unless you had abandoned all of your blue chips to chase dot com stocks exclusively, it wasn't the end of the world. It should be noted that the tech crash was augmented by the uncovering of massive frauds at both Enron and WorldCom and punctuated with the September 11th attacks.
The worst of these eleven crashes took place from April of 1930 and ended July of 1932, investors had lost 86% of their money in just 813 days. This was the big one, far grislier than the 48% killer of the fall of 1929, although that '29 crash took place in an astonishing two months. Within a few years, stocks would crash twice more. The Dow once again dropped 47% from March 1937 through March 1938 and then another 40% between September 1939 through 1942. This was followed by the Second World War and it took until the late 1940′s before stock prices had fully recovered.
From the peak in 1929, on a simple price basis, the Dow wouldn't reach news highs until 1954. Have a look at Yardeni Research's Bear Markets & Corrections Since 1929 for even more charts and data.
We have had many more examples of corrections than crashes, for the obvious reason that not every 10 percent correction turns into a 30 percent-plus crash, but every 30 percent crash contains a 10 percent correction within it. Even the 1987 one-day 23 percent crash began 15 percent off the prior highs.
Just in the post-war era (1945-present), there have been 27 corrections of 10 percent or greater, more than double the 12 bear markets of down 20 percent or more. The average decline is 13.3 percent over the course of 71 trading days.
Ed Yardeni points out that from 1982 through the 1987 crash, there was but one 10 percent correction. Between that crash and the secular bull market's March 2000 peak, there were just two corrections of 10 percent or more. The takeaway from this is that markets can go quite a few years between corrections.
Brown further notes that in the present era, beginning with the March 2009 lows, we have seen only 3 corrections greater than 10 percent: Spring 2010 had a 16 percent, 69-day drop in the S&P 500; the 2011 summer correction was just under 20 percent over the course of 154 days; Most recently, 2012 spring was barely a correction, with a peak-to-trough drop of 9.9 percent in under 60 days.
It is easy to underestimate the depth of dislike for this market rally. A mere 1 percent drop reveals the bears are much more passionate then the bulls, most of whom feel they have no choice but to have significant equity exposure, especially to U.S. stocks. In my office, we had been significantly underweight bonds and overweight equities in 2013. We have trimmed U.S. equities some, added more European exposure, and --given the negative consensus on bonds -- we added preferreds and corporate fixed income this month.
Bullish sentiment has gotten frothy, and markets have become overbought. But they can stay that way -- "persistently overbought" ---for extended periods of time.
Rather than guessing when this bull market ends, investors do have other options to select from. You can be prudent without embracing the idea an imminent crash is coming each time markets twitch 1 percent. I don't know how some of you guys behave otherwise. A full blown war cry of doom each time markets go into spasm sounds exhausting to me.
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Barry L Ritholtz at email@example.com