Market Corrections Are More Common Than You Think

February 22, 2022
Taking a moment to review your risk profile can help prepare you for when the next "market correction" arrives.

Financial markets kicked off 2022 with renewed volatility amid persistent inflation concerns, expectations for Fed rate hikes and escalating geopolitical tensions over Russia and Ukraine. For more insight into how geopolitical risk can affect markets, see this market commentary update. In late February, the S&P 500® Index closed in "correction" territory, defined as a more than 10% pullback from its last all-time high. The recent turbulence was the most severe since the 34% decline that occurred in Q1 2020.

Market corrections can cause a lot of anxiety. However, keep in mind that the S&P 500 only measures one asset class, U.S. large company stocks. Schwab Intelligent Portfolios® diversifies across stocks, bonds, commodities and cash to help moderate overall portfolio volatility and drawdowns when the equity markets become turbulent.

Additionally, financial markets have historically seen a significant pullback at some point during most years while still delivering positive returns over the full year. For example, in 2018, the S&P 500 saw a market correction of more than 10% in the first quarter of the year and again in the fourth quarter, followed by a rebound of more than 13% in the first quarter of 2019. And the tumble in Q1 2020 was followed by a positive return of 18% for the full year and a gain of more than 100% in less than two years.

These market corrections are more common than you might think. Over the seven years since Schwab Intelligent Portfolios was launched in March 2015, there have been five corrections and one bear market. A bear market is a pullback of at least a 20% decline from a recent high.

These occasional pullbacks have historically been followed by rebounds, according to the Schwab Center for Financial Research. Since 1974, the S&P 500 has risen an average of more than 8% one month after a market correction bottom and more than 24% one year later. Investing in a diversified portfolio and maintaining the discipline to stick with your longer-term plan through these periods of volatility are among the keys to long-term investment success.

Stock market corrections are not uncommon

To illustrate the volatile nature of financial markets, we took a look at intra-year stock market declines over the 20-year period from 2002–2021. As you can see in the chart below, a decline of at least 10% occurred in 10 out of 20 years, or 50% of the time, with an average pullback of 15%. And in two additional years, the decline was just short of 10%. Despite these pullbacks, however, stocks rose in most years, with positive returns in all but 3 years and an average gain of approximately 7%.

Figure 1: Stock market corrections are fairly common. Pullbacks of 10% or more occurred in 10 of the past 20 years

Index annualized total return (2002-2021), which shows that missing just the top 10 days in the market over the past 20 years would have cut annualized returns by nearly half.

Source: Schwab Center for Financial Research with data provided by Standard & Poor's.

Return data is annualized based on an average of 252 trading days within a calendar year. The year begins on the first trading day in January and ends on the last trading day of December, and daily total returns were used. Returns assume reinvestment of dividends. When out of the market, cash is not invested. Market returns are represented by the S&P 500® Index. Top days are defined as the best-performing days of the S&P 500 during the 20-year period. Indexes are unmanaged, do not incur fees or expenses, and cannot be invested in directly. Past performance is no guarantee of future results.

Having a longer-term plan and sticking to it is key to investment success

The last bull market brought gains of more than 400% over 11 years. The current bull market has seen an advance of more than 100% in less than two years, following the shortest bear market (1 month) in recorded history. A bear market of at least a 20% decline will occur again at some point, but it's important to keep it in perspective. The average bear market has lasted only about 15 months, according to the Schwab Center for Financial Research, and 80% of corrections since 1974 have not led to a bear market.

It remains to be seen whether the recent market volatility has reached its crescendo or whether the turbulence might continue. Either way, it's important to remember that market pullbacks are not uncommon — and occur in most years. These market corrections can be healthy in resetting stock valuations and investor expectations within a longer-term market advance. We know that markets can be volatile in the short term. But we also understand that having a long-term strategic asset allocation plan and sticking to that plan through periods of market volatility can help keep you on the right track toward reaching your financial goals.

Schwab Intelligent Portfolios is designed to provide broad diversification across up to 20 asset classes in any portfolio, including defensive asset classes such as cash and gold that can help you withstand these inevitable periods of volatility. This broad diversification along with an automated rebalancing process can help provide the discipline to remain calm during periods of short-term volatility while staying focused on longer-term objectives.

David Koenig CFA®, FRM®, Vice President and Chief Investment Strategist for Schwab Intelligent Portfolios