The S&P 500 Joins the Nasdaq in Correction Territory: What’s Next?

On Thursday, March 13, the S&P 500 (^GSPC) closed 10.1% below its all-time high reached on February 19, signaling a swift decline that pushed the index into correction territory. By the same date, the Nasdaq Composite (^IXIC) was already experiencing a correction for several days.

A correction occurs when an index falls 10% or more from its recent peak, whereas a bear market is defined by a longer-term decline of 20% or more from its highest value.

This article explores what might happen next as the broader market continues to exhibit volatility and experiences significant drops.

Navigating Stock Market Corrections

In general, when corrections occur, the market tends to recover rather than spiral into a bear market. Interestingly, on the following Friday, the S&P 500 managed to exit correction territory with a 2.1% gain, trading approximately 7.5% below its all-time highs by Monday afternoon.

Research by Yardeni indicates that between 1929 and 2024, there have been 56 corrections, with 22 of these events (about 39.3%) escalating into bear markets. However, bear markets have become less common in recent times. Since 2010, 10 corrections have taken place—two of which turned into bear markets, specifically the sell-off during the pandemic in 2020 and the bear market of 2022. While corrections appear to be frequent, a lower-than-average number has slid into bear markets. In every scenario, those who bought during the dips saw significant returns in the long run.

For instance, the last correction occurred in October 2023, during a recovery process after the 2022 downturn boosted by artificial intelligence (AI) investments. This correction proved to be short-lived as the S&P 500 surged by over 20% in the subsequent years.

Data from YCharts shows that over the past 15 years, the S&P 500 has delivered a total return of 540%, even at times falling by as much as 34.7%. Investors holding an S&P 500 index fund experienced remarkable returns, provided they were prepared for significant fluctuations.

Looking at the long-term performance of the S&P 500, it’s evident that the appropriate approach during bear markets is to buy more shares. A wise strategy during downturns is to hold onto existing stocks rather than sell. However, this doesn't mean investors should ignore the health of their portfolios or be complacent about long-term challenges.

Know What You Own and Why

Historically, the S&P 500 has recovered from every correction and bear market; however, this doesn’t guarantee the same for all individual stocks.

The market's history includes numerous stories of failed growth ventures and misplaced valuation expectations, leading to dramatic losses for some stocks.

A stock market correction can provide an excellent opportunity to examine your investments and ensure you understand the rationale behind each holding. It’s also prudent to review any index funds or exchange-traded funds (ETFs) you may own.

For instance, just because an ETF comprises many holdings does not imply it is diversified. The Vanguard Growth ETF (VUG), one of the largest growth ETFs with over $280 billion in assets, allocates about 61% of its resources to just ten companies.

If you’re interested in these ten companies, this concentration might not be a concern. Nonetheless, it's advisable to be aware of the leading holdings within any ETF you invest in and how they impact overall performance. A substantial 77% of the Vanguard Growth ETF’s assets are concentrated in growth-oriented sectors such as technology, communication, and consumer discretionary, leading to a lower dividend yield and a higher price-to-earnings ratio compared to the S&P 500.

Getting Comfortable with Market Fluctuations

Investment expert Peter Lynch, who led his funds to exceptional returns from 1977 to 1990, once addressed the inevitability of market corrections and bear markets. He noted that investors must accept that market downturns are part of the investing landscape and can be leveraged for advantage if one understands their holdings.

Volatility represents the cost of doing business in the stock market, contrasting with risk-free assets such as CDs or U.S. Treasury bills.

Lynch wisely indicated that if you can't tolerate the ups and downs, then stock ownership may not be for you. However, if you can manage the stress during downturns, a long-term strategy of buying and holding stocks can lead to exceptional wealth accumulation.

Note: The author does not hold any positions in the mentioned stocks and the organization has stakes in or recommends Vanguard Index Funds and the Vanguard Growth ETF. Disclosure policies apply.

correction, market, stocks, investing