A Stock Correction Doesn't Mean the Market Was Wrong

The S&P 500 Index officially fell into a correction on Tuesday, tumbling 10% from its record high on Jan. 3. The benchmark for U.S. stocks extended its decline on Wednesday, dropping as much as 1.8%. The word “correction” implies something was “wrong” with stocks. It’s true that the outlook for equities has dimmed with inflation raging, the Federal Reserve preparing to tighten monetary policy, fiscal stimulus having ended, oil flirting with $100 a barrel and global geopolitical tensions worsening between the U.S. and Russia over Ukraine. But none of that means the next stop is a bear market, defined by a 20% plunge from the last record high.

The first thing to know about corrections is that they are common. There have been 33 of them since 1950 for the S&P 500, and it has been almost two years since the last one, according to LPL Financial. Historically, corrections have been a good time to buy, with equities rising about 90% of the time over each of the following 12 and 24 months, LPL found. Returns averaged 24.8% one year after a bear market and 37.4% two years later.

There’s no guarantee history will repeat, but it’s notable that the weakness in equities comes amid some strong fundamental performance for companies. With earnings season wrapping up, 78% of the S&P 500’s members beat Wall Street’s revenue estimates for the fourth quarter, above the 68% average over the past five years, according to DataTrek Research. Earnings beat estimates by 8.5%, in line with the five-year average of 8.6%. At 12.5%, profit margins were better than pre-pandemic averages of 10% to 11%, the firm said.