As the markets continue to move up and down and as the media continues to have a field day playing with our emotions, it is no wonder that many investors find themselves questioning what lies ahead. While no one can predict what the markets will do or how people will react to the news of the day, it is helpful to understand some key terms that are being thrown around: namely market correction, bear market, and recession.
A market correction is defined as a drop of at least 10% from a recent high. This can be a drop in an individual stock, in an index or in the market as a whole. Market corrections are typically short-lived (a few days to a few months), and they occur about once a year. While markets generally exhibit a long- term positive trajectory, we know that markets cannot go straight up at all times. Think of a correction as the market simply taking a breather.
A bear market is defined as a drop of 20% or more from a recent high. Bear markets typically reflect general pessimism among investors, and may or may not be associated with a recession. Since 1945, there have been 16 bear markets ranging in length from about 45 days to 2.5 years. Most recently, U.S. stocks experienced a bear market from mid-September 2018 to December 24, 2018. Bear markets can be unnerving and frightening, but they are surprisingly common. Successful investors plan for bear markets and generally view them as necessary.
A recession is an economic slowdown defined by two consecutive quarters or more of negative GDP growth. Oftentimes, recessions result in higher unemployment rates, reduced purchasing power, and poor business performance. Whereas market corrections and bear markets reflect investor sentiment, recessions reflect actual economic hardship. The U.S. has experienced 12 recessions since 1945. They are notoriously difficult to predict, and how and when a recession will impact the stock market is even more difficult to forecast. In many cases, the market has already begun its recovery before we even know that we are in a recession.
Corrections, bear markets, and recessions will happen. A well thought out financial plan will incorporate this inevitability and provide a roadmap for success despite them. However, even the best financial plan may not recover if that plan and accompanying portfolio is abandoned for the safety of cash as a reaction to media-driven fear or panic. If you plan appropriately and stick to that plan regardless of what the market is doing, there is no reason to be fearful or anxious.
Speaking of the media, it’s useful to remember that the media will generally highlight negative news over positive news because negative news is better for ratings. The media may feature articulate stock market gurus who are predicting the next bear market or recession, and eventually, they will be right. The question is, when? Will the next bear market start tomorrow, or years from now when stocks are 50% or 100% higher? The truth is, no one knows precisely what lies ahead. We can therefore confidently ignore market forecasters and instead focus on our plan.