Will The Market Pullback Be A Correction Or Bear?

The speed (or lack thereof) with which the S&P 500 finally succumbed to the 5% decline threshold may offer a clue to the likely magnitude of the overall decline. The speed of decline, in our opinion, is reflective of investor behavior. A sharp and swift decline – like yanking off a band aid – ends up being over quickly since investors acknowledge with a nervous chuckle that they overreacted.

Hence during the 19 times that the S&P 500 fell the first 5% in nine days or fewer, only 21% of these declines slipped into correction mode and none evolved into a bear market. Conversely, for those 16 times that the S&P 500 took its sweet time (40 days or more) to fall 5%, the “500” slid into correction mode only once, and never became a bear market. The rationale is that a drawn-out decline gives investors time to evaluate the concerns and dissipate the impact.

Probability of a Pullback Becoming a Correction or Bear Depending on the Number of Days the S&P 500 Took to Fall 5%

What does this decline tell us? At 92 calendar days, this is the longest it has taken the S&P 500 to decline 5% since WWII. In the prior two times it took more than 80 days to cross the 5% decline threshold, one fell only 6.2%, while the other dropped a total of 14.8%. This time around, a correction is more likely, since the “500” has not experienced a decline in excess of 10% for more than 47 months, versus the average of 18 months since 1946.

Investors have endured a white-knuckle ride on the S&P Cyclone that may not be over. History says, but does not guarantee, however, that the S&P 500 will likely not slip into a new bear market, based on the length of time the S&P 500 took to fall by 5% since the prior market top, combined with the strength of the U.S. housing market and today’s low level of inflation (more on this in next week’s Sector Watch).

Even though a correction is the most likely outcome, in our view, investors are advised not to try to time the market, since corrections required an average of only four months to get back to break even. You may get out in time to avoid further carnage, but you probably won’t know when to get back in, and will likely do so at a level higher than where you exited.

That said, depending on the depth and duration of this decline, two stock market records are at risk. Should the S&P 500 slip into a correction, the four months typically required to get back to break even might result in a negative performance for the “500” in 2015. A down year for the S&P 500 in 2015 would be the first time since 1945 that the third year of the Presidential cycle would be negative, and the first time since 1905 that a year ending in “5” closed lower.

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