August 2023
Equity Corrections During Strong Years Are Normal
August 22, 2023
Equities have pulled back 4.5% since the end of July, cutting the S&P 500’s year-to-date gains to 14.2%. But investors shouldn’t be alarmed. Our analysis shows that corrections are normal, even during the strongest years for stocks.
We’ve seen corrections of 10% or more occur nearly half the time stocks have had a good year, with good defined as a 10% return or more on the S&P 500. Additionally, declines of at least 5% from the peak have occurred almost 90% of the time in the 49 good years we’ve had since 1928.
We expected some consolidation after such a strong rally in the first seven months of the year. Sentiment in June was its most bullish in two years, which is often a sell signal for contrarian investors. AI mania fueled a rally in mega-cap tech names, pushing the price-to-earnings multiple of the S&P 500 above 19 times and the 10-year Treasury yield jumped to above 4%, sparking recent weakness.
However, we believe stocks will resume their upward trend once valuations return to more attractive levels. The fundamentals behind the market’s upside bias remain in place: Inflation is trending toward the Fed’s target, and many expect the U.S. to avoid a severe recession despite the Fed’s aggressive tightening. We also expect longer-term yields to trend lower once the market believes the Fed is done hiking rates.
Although corrections are a normal feature of market cycles, it doesn’t mean the stock market is without risk. However, it does reinforce the argument to stay invested and keep a longer-term perspective.
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