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Correction May Come Sooner Rather than Later

December 10, 2020

bar chart showing the Time Before First Correction by Bull Market

Source: Standard and Poor’s

This bull market has yet to hit the nine-month mark and the S&P 500 has already surpassed the first-year gains of all but two of the prior cycles on record. A strong start alone bodes well for the trend moving forward, as the bull runs that have gotten off to the best jumps out of the gate have in general produced the biggest cumulative increases (this is to say nothing about the extremely constructive fundamental backdrop, which is even more emphatically pointing to solid performance in the years ahead).

Of course, there are hiccups in even the healthiest of markets and it is to be expected that the S&P will its first speed bump before long. Corrections are inherently unpredictable, but they have historically come just over a year on average after bear market troughs with at least one in the first two years of every cycle since the 1940s. And while valuation levels have correlated poorly with both the length and the overall performance within bull markets, they have been decent leading indicators of the timing of the first blip of the cycle; more expensive markets, such as this one, have corrected sooner, cheaper markets have corrected later.

Perhaps the best test of whether this cycle is heading for a 1990s-like euphoria will be how investors react once a pullback of this nature inevitably unfolds. There were actually three corrections across a two-year span in the late 1990s, but all were quite short, lasting an average of just over a month and a half versus a long-term average of over four months, and all saw big gains in their aftermath, with the S&P moving up by an average of 20.7 percent over the subsequent six months (along these same lines, there was a similarly truncated correction during the roaring 1920s that gave way to a 22.8 percent increase in the six months after its conclusion). There have been plenty of signs this year that a ‘buy the dip’ mentality will take hold again in this cycle, but, of course, it will take a true dip to prove that conclusively.


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