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Equity markets kicked off 2022 with a correction, and with a moderate correction at that. In review, I regard a garden variety mild correction to be when equity markets decline around -5%, with a moderate correction at approximately a -10% decline, and a severe correction to be a drop of -15%. Opinions can vary and can be very subjective depending on exactly what market and what time frame is considered. For example, oil markets can be correcting the same time equity markets are climbing, and vice versa, which happens to be the case in 2022. Some don’t even call a correction until there is a -10% decline.
In 2021 we saw eight mild corrections for the Dow Jones Industrial Average (DJIA) and no moderate or severe corrections. Equity markets have averaged just three mild corrections in a year, so in short, it was a roller coaster year with several reversing market rotations. Very tricky! The frequency of moderate to severe corrections with equities depends on the index and period. For example, the NASDAQ Composite Index has averaged a greater than -10% decline every nine months since 1971. Since 1929, the S&P 500 Index has registered a greater than -10% decline about once every twelve months. Yet markets can rebound quickly. Despite averaging a double-digit correction per year, the S&P 500 Index has finished with positive returns in 31 of the last 41 calendar years. The last time that we saw a moderate correction for equity indexes was in March of 2020, sparked by the COVID shutdowns. That was 22 months ago. So the current correction shouldn’t come as a big surprise, or as a strong concern going forward.
Bond market corrections behave differently. The Barclays U.S. Aggregate Bond Index (AGG) has only experienced two corrections greater than -10% since 2004. The first was a result of the Financial Crisis in 2008. The second as a result of the COVID shutdowns in 2020. In both cases prices fully recovered inside of three months. The AGG is now in a mild correction of -4.0% dating back to August of 2021. On the other hand, the more volatile Barclays 20+ Year Treasury Bond Index has dropped greater than -10% on eleven occasions since 2003, and is now in a -10% correction dating back to the first week in December 2020. These were all total return corrections, meaning bond interest was included.
Getting back to January of 2022, all but one of the equity major market indexes have declined MTD as of Friday the 28th. The S&P 500 Index is down -6.93%, the S&P 400 MidCap Index is down -9.22%, and the S&P 600 Small Cap Index is also down -9.22%. The only index that has gained ground in January is the S&P Composite 1500 Energy Sector, up an impressive +17.72%, which mirrors the advance in light crude oil prices YTD. Since their December 2nd 2020 low of $62.43/bbl, light crude has soared by almost 43% to $86.82/bbl. Speaking of corrections, in just the last three years, Light Crude Oil has had eight corrections of greater than -15%. This including the massive -89.9% COVID correction in the first quarter of 2020, when prices plummeted from $65.65/bbl down to $6.50/bbl. The hardest hit equity sectors YTD are internet, consumer discretionary, and information technology. Developed international equities are down a little over -5%, and emerging markets equities are down a little more than -3% YTD.
At this juncture it is still too early to verify a bottom to the current correction. That being said, the most severe type of correction, also known as a Bear Market, is graded by declines in excess of -20%. Bear Markets for U.S. equities have nearly always been associated with economic recessions. An economic recession in 2022 is absolutely off the table as the economy is still expanding from the initial COVID shutdowns in 2020. Corporate earnings are still growing, unemployment is low, and interest rates are still low. These are primary factors taken into consideration when calculating equity prices. Bonds are facing headwinds with rising inflation and interest rates. We have seen significant rotation in January from Growth to Value sectors. This is an indication of slower growth, but growth indeed. It’s been a rough start, but it is very early.
Edward D. Foy, Manager, SELECTOR® Money Management, Chief Investment Officer, Foy Financial Services, Inc.