In times of market declines it is good to remind ourselves the difference between a correction and a bear market.
-George Bijak, investment strategist and managing director, GB Capital Pty Ltd.
We had a nasty stock market corrections in the middle of 2010, 2011 and 2012 caused by political uncertainty about Europe's debt.
In times of market declines it is good to remind ourselves the difference between a correction and a bear market.
From a technical point of view correction is when the market falls short of a 20% decline; more than 20% drop is a bear market. From a fundamental perspective during corrections investors expect future earnings to fall so they put lower valuation multiples (P/Es) on the current earnings. If the earnings do not fall or continue to rise P/E rebounds and bull market resumes. If earnings do fall, the P/Es may drop further resulting in a bear market.
So corrections are panic attacks that aren't confirmed by the fundamental earnings trend. No wonder that stock market's behavior is often compared to that of a manic depressive.
As you can see in the below chart, S&P 500 index (red) market's volatility since early 2009 bottom is attributable almost entirely to the volatility in the P/E. The USA earnings are in a clear sharp uptrend and that is why the corrections did not turn into a bear market and an economic recession. The blue lines represent S&P 500 index value at theoretical constant P/Es ranging from 10 to 15 times.
