In a sense, this move was long overdue. Research by Sean Williams of the Motley Fool finds that the S&P 500 has corrected 33 times and spent about 28% of its life in correction territory over the past 65 years. Waiting four years between corrections is unusually long.
Corrections are a normal, recurring phenomenon, but investors can have short memories. The irony of going so long between corrections is that the possibility of correction feels more remote as the next correction becomes more overdue. Media outlets including CNN, Bloomberg, NBC, The Washington Post, Chicago Tribune, Business Insider, and MarketWatch all referred to August’s move as “wild” or “a plunge.” It was no such thing in our opinion, just the sort of garden variety downswing that typically comes along every couple years. The short time over which the correction unfolded was unusual, but downward moves have always happened much more quickly than upward moves throughout stock market history.
Pardon the analogy, but we are reminded of standup comedian Chris Rock’s observation after a tiger mauled its handler during a live Las Vegas magic show. The media lit up saying the tiger went crazy. “No he didn’t.” said Rock, “that tiger went tiger.” Mauling things is what tigers are supposed to do. So it goes with the stock market; choppy long-term gains and occasionally violent short-term losses is exactly what the stock market has always done. Again, that’s why stocks are called risk assets.
Here is the single most important thing to know about risk: the stock market’s riskiness is strictly a short-term phenomenon. Over long periods of time, stocks show positive inflation-adjusted returns. The same cannot necessarily be said for supposedly safe assets like gold, whose value has only about kept up with inflation historically, nor government bonds, which are currently priced to yield just 2.26% for ten-year notes. Inflation is likely to run higher than that over the next ten years, meaning government bonds have a high probability of losing purchasing power. This is very unlikely to be true of the stock market. Even using the very conservative CAPE ratio, which divides the current level of the S&P 500 by a 10-year average of its earnings, stocks are still priced to return something in the range of 7% going forward, based on a 5% earnings yield plus 2% underlying economic growth. Our leading growth companies have typically fared several percentage points better.
Despite the recent S&P 500 correction, the economic data says this is an unusually good time to be in U.S. stocks, compared with the prospects for other advanced economies, and also compared to other asset classes, especially bonds. Over both short periods and long ones, the stock market will continue to act like the stock market, and that’s just fine.