Riding the Waves: Understanding Stock Market Pullbacks

April 23, 2024

In the unpredictable realm of the stock market, understanding the phenomenon of pullbacks is essential for any investor. Markets pullbacks, often feared and misunderstood, are a temporary decline in stock prices within an otherwise upward-trending market. While it may stir panic and uncertainty among investors, a closer examination reveals that pullbacks are components of market cycles and can in fact be healthy. Here we’ll look at the intricacies of stock market pullbacks, exploring their causes, characteristics, and most importantly, strategies for not only weathering the storm but also capitalizing on the opportunities they present.

A pullback is a falling back of prices from their peak, from -5% to -10%. This decline in price may be seen as a brief reversal of a prevailing upward trend of the market. A correction is a larger fallback from the peak, -10% up to the -20% mark of a bear market. Corrections are slightly longer temporary declines that interrupt an overall uptrend in the market. They are shorter in duration (usually a few months or less) than a bear market, but it can be a precursor.

Pullbacks and corrections can be healthy pauses in an overall upward trending market. A pause in a bull market can allow investors breathing room to reassess and refocus. Markets that have become overpriced can use a pullback to make sure interest in certain areas of the market is warranted and for prices to come back in line with fundamentals.

Market pullbacks are not uncommon. In the 20-year period from 2002-2021 a decline of at least -10% occurred in 10 out of the 20 years. Two more of those years had declines just short of -10%. However, despite these pullbacks, stocks rose overall in all but three of those years with an average annual gain of approximately 7%. As you can see in the chart below, going back to 1980 the average intra-year drop is 14.2% but there were positive returns in 33 of those 44 years.

The causes of market pullbacks vary widely from market sentiment and investor psychology to economic indicators and geopolitical events. The broad spectrum of factors that can initiate a market pullback make them almost impossible to predict with any kind of reliability, but that’s ok. Even when markets are faced with more severe correction or bear markets, history has shown that they always bounce back. Since 1974, the S&P 500 has risen an average of more than 8% one month after a market correction and more than 24% one year later! Investors with a diversified portfolio can weather the storm and come out on top by sticking to their long-term plan through periods of volatility. The worst choice investors can make is to let their emotions guide investment decisions, which is particularly hard in periods of pullbacks and corrections when panic can set in.

Pullbacks and corrections are part of the normal market cycle. While they don’t feel good to experience, they can actually be a healthy part of an overall growing market. The trick to coming out on top of the choppy waters is to stay calm and maintain rational, long-term investment goals in a diversified portfolio. This can be easier said than done and working with a trusted wealth management partner like DWM can make navigating difficult times in the market much easier for individual investors.

Detterbeck Wealth Management is a fee-only financial planning / wealth management company with offices located in Palatine, IL (Chicago area) and Charleston, SC areas serving clients locally and across the country. To contact us about setting up an appointment, please see our contact us page