The US Nasdaq index has now lost 30 % of its value since its peak last November. Since this index is largely made up of technology companies, one can imagine the carnage that has taken place in this segment of the market in recent months.
As for the S&P 500 index, it is now down just over 18% since its peak last January.
Finally, the Canadian S&P/TSX index has lost 11% since its recent peak in March. The Canadian index has done a little better compared to the American indices due to the strong appreciation of its energy sector (up 30.8% in 2022 as of April 29) and, to a lesser extent, that of base metals (13.9%).
We know that a decline of more than 10% from a recent high is technically called a “correction”, while a drop of 20% or more is a “bear market”. The Nasdaq index has officially been in a bear market for a few weeks and the S&P 500 index is getting dangerously close.
How to explain such a drop in the stock markets in such a short time?
First of all, it is in my opinion very difficult, if not impossible, to explain such stock market movements with certainty. Many will point to rising interest rates as the main culprit for the stock market crash; it most likely had a significant impact. The fact remains that there are so many variables that come into play, including human psychology, that identifying the causes of stock market corrections is difficult.
The important thing is to remember that such stock market corrections are normal and recurrent. The investor who invests in the stock market for the long term must prepare mentally for such painful episodes because they are an integral part of the experience of the long-term investor.
From 1928 to 2021, there were 55 stock market corrections (on average one every 1.7 years), 21 bear markets (declines of 20% or more; one every 4.5 years), 13 declines of 30% or more (one every 7.2 years) and three falls of 50% or more (one every 31 years). But that hasn’t stopped the market from providing excellent returns for long-term investors: over the period, the annual compound return of the S&P 500 was 9.98%.
If there is to be a reason behind the recent market correction, I would point to the high level of speculation that has encompassed the markets for some years, particularly since the pandemic. “Day trading”, margin investing, cryptocurrencies, speculation focused on unprofitable companies are all factors that have made the markets appreciate for two years and have caused them to fall for a few months.
In my opinion, the investor who has invested in companies that are financially solid, that are profitable and in good financial health and whose security is reasonably valued should not worry too much about the decline of the markets.
If anything, the correction will have significantly improved the outlook for returns over the next few years. Moreover, I believe that we are witnessing a cleaning up of the stock markets and an elimination of the speculative excesses of the past few years. Such adjustments are recurrent and very healthy for the markets – remember what happened in the early 2000s when the tech bubble burst: fundamental values were back on the agenda.
We could well see the same phenomenon in the months to come.
