The full title of the classic 1964 movie is “Dr. Strangelove, Or: How I Learned to Stop Worrying and Love the Bomb”. Income focused stock market investors need to follow the advice of Dr. Strangelove and get ready to “love the correction” that many news hosts and experts are forecasting for the stock market.
Financial experts define a stock market correction as a 10% to 20% decline in the value one or more of the major stock market indexes. If the drop exceeds 20% we are into bear market territory. Historically, most bear markets are closely timed with economic recessions. On average, a real bear market occurs once a decade or so. Corrections are more random, and historically the market has dropped by more than 10% about once every two years. However, it has been 3 1/2 years since the last correction in November 2011.
It is hard to find a reason for a correction, especially in advance. These drops tend to feed on investor fears until buyers get brave enough to jump in. Widely-followed financial writer and money manager, James A. Kostohryz recently gave one of the better descriptions of a correction:
“Pullbacks tend to develop into significant corrections largely as a result of traders and investors being caught “wrong-footed”, which sets off a cascading series of selling waves. These selling waves may be largely unrelated and/or uncorrelated to the evolution of underlying fundamentals. The selling waves are fueled by several non-fundamental factors. For example, stop-loss levels are breached, forcing traders to quickly and indiscriminately exit positions. Another factor is related to emotion: Faced with a surprise or being caught off-guard, or perhaps influenced by “herd” mentality, investors and traders may react impulsively. Again, often some sort of fundamental event is the initial catalyst to the waves of selling, but the selling dynamic then takes on a life of its own.”
Although it is probably impossible to predict the next market correction, it would not be a surprise to have the stock indexes pull back by 10% or more at some point over the summer and into early fall. It has been quite a while since investors felt the pain of a correction, so it is possible that any correction could test the 20% drop limit of the definition.
