What to do after a correction ?

In our view, the January sell off was “just” a correction and not the beginning of a bear market. So, even if we should not be under the illusion that the market will return to its peak level rapidly, this drop could be considered as a good entry point.

As a reminder, a stock market correction is defined as a cumulative market decline of more than 10%, but of less than 20% (when it becomes a bear market). In this case, we consider that the January sell-off was in fact a correction of the S&P 500 (as it plunged -9.7% between 3 and 27 January), triggered by the tightening of the Fed’s stance (resulting in a 60bp rise in real bond yields) and the derating of the US index, largely via tech stocks. The Ukraine-Russia conflict probably exacerbated the decline in appetite for risk.

In general, there is no reason in itself to panic during or after a correction. It must be recalled that the average infra-annual drawdown of the S&P 500 since 1964 was 10.9% (see chart infra).

Since 1960, the S&P500 has seen 23 corrections (leaving out that of January, see table infra).

S&P 500 – CORRECTIONS OR QUASI-CORRECTIONS SINCE 1960

Peak Trough Change Days
03/08/1959 25/10/1960 -13.9% 449
13/05/1965 28/06/1965 -9.6% 46
25/09/1967 05/03/1968 -10.1% 162
28/04/1971 23/11/1971 -13.9% 209
07/11/1974 06/12/1974 -13.6% 29
15/07/1975 16/09/1975 -14.1% 63
21/09/1976 06/03/1978 -19.4% 531
05/10/1979 07/11/1979 -10.2% 33
13/02/1980 27/03/1980 -17.1% 43
10/10/1983 24/07/1984 -14.4% 288
09/10/1989 30/01/1990 -10.2% 113
18/02/1997 11/04/1997 -9.6% 52
07/10/1997 27/10/1997 -10.8% 20
17/07/1998 31/08/1998 -19.3% 45
16/07/1999 15/10/1999 -12.1% 91
22/08/2002 09/10/2002 -19.3% 48
23/04/2010 02/07/2010 -16.0% 70
29/04/2011 03/10/2011 -19.4% 157
02/04/2012 01/06/2012 -9.9% 60
21/05/2015 11/02/2016 -14.2% 266
26/01/2018 08/02/2018 -10.2% 13
20/09/2018 24/12/2018 -19.8% 95
02/09/2020 23/09/2020 -9.6% 21
Mean -14% 126
Median -14% 63
03/01/2022 27/01/2022 -9.7% 24

 

Source: Refinitiv, Les Cahiers Verts. A correction is defined as a stock market decline of 10% (rounded up) from peak to trough, but of less than 20% (bear market). A correction ends at the trough preceding the return to the previous peak level.

 

Corrections are typically quite sudden: the median decline is 14% and lasts three months from peak to trough. Interestingly, 50% of the median decline is reached 19 days after the peak and 70% of the decline 40 days after the latter.

Finally, the markets take about nine months (median) to return to their peak (see chart infra). That’s why we should not be under any illusion that the sudden decline of January will be retraced rapidly.

Experience shows that, in the US, corrections are good entry points on average when they are not followed by a recession. When you buy at less than 10% below the peak, performance is positive one year forward three quarters of the time.

Therefore, if we rule out a forthcoming recession, what are the key variables for a rebound (or rather a further rebound) in the short term. We see four factors:

  • First, appetite for risk. Most indicators (RSI, VIX and put/call ratio, surveys etc) tend to show a neutral to moderately weak level.
  • Then, investor positioning. The correction was too sudden to alter behaviour. Our indicators remain above the historical average (see chart infra for individual investors).

  • US monetary policy obviously. With almost 6 rate hikes priced in and the balance sheet reduction projected for next summer, we believe we are largely shielded from bad news. A 50bp rate hike at the March FOMC is also priced in.
  • Finally corporate results. Based on 69% of S&P 500 companies that have reported so far, 77% are beating 4Q earnings and 75% are beating revenue estimates. Earnings have surprised to the upside by 10.2%. The problem is that guidance (for companies that gave guidance) was less pertinent, while last year was particularly good from this standpoint. In addition, investor concerns are starting to be reflected in H1 economic momentum (see chart infra).

In summary,  there is no clear determinant for an aggressive position on risk asset markets in the short term, especially as the current situation in Ukraine constitutes potential threats to equity market. But once again, let us remember that corrections are good entry points on average when they are not followed by a recession.