The US stock and bond markets have entered correction territory, defined as a 10% or greater decline. The S&P 500, as measured by the iShares Core S&P 500 ETF (IVV), has fallen 13.08% year-to-date. The US aggregate bond market, as measured by the iShares Core US Aggregate Bond ETF (AGG), has fallen 10.41% year-to-date.1 The primary source of consternation among investors is inflation. Rising prices, and the US Fed Reserve actions to control inflation, have far-reaching consequences for all assets, including stocks and bonds.
As a reminder, the US Federal Reserve has two mandates: full employment and controlled inflation (targeted around 2.5%). While the current employment situation is robust, the recent inflation numbers are significantly above target levels. The Fed, in an effort to control future inflation, have raised the federal funds rate by 0.75% year-to-date. While the Federal Reserve has greater control over short-term rates, the 10-year US Treasury rate has increased as well. As of May 9th, the 10-year US Treasury rate is 3.05%, an increase of 153 basis points from this point last year. 10-year US Treasury rates are also at their highest level since November 2018.2
As with bonds, inflation and Fed actions to curb high rates of inflation have implications on the stock market as well. Rapidly rising prices in necessities like food and gas can act as a pseudo-tax on consumers and leave them with less ability to spend on other things like travel and restaurants. Further, for companies, rising input costs and wages can negatively impact profitability and therefore earnings growth could slow. When the Fed acts aggressively to curb rising prices, it also has a side effect of slowing growth. Combining all of these forces have created a nervous stock market and, as such, we have experienced a correction in the S&P 500 and a bear market (more than 20% decline from highs) in the Nasdaq.3
In the context of market history, corrections aren’t that unique. The chart below shows that we have 5% declines nearly every year and corrections of 10% are not terribly uncommon (orange bar). Notice how these corrections can even happen during positive performance years (blue bars).4
Despite these corrections, markets actually still provide many more positive to negative years. Based on the chart below, the odds of being positive are nearly 3 in every 4 years.
The times after a market correction are generally positive over the course of the next 2 years. The chart below helps illustrate that, after a large decline in the first quarter, the rest of the year has generally been a favorable market, with an average return for the rest of the year being over 40%.5
Overall, the stock market is almost never a straight line upward. To generate higher than average returns, investors must deal with volatility that, especially in times of correction, can feel painful. The way to achieve those higher returns is not by timing the market, but rather time in the market. Staying prudent, with both safe and growth assets, that fit your objectives and risk tolerance remain the best ways to achieve your financial goals. Corrections, while painful, usually end up providing opportunity to add further value in the future.