With all three U.S. stock market indices down on Monday by an average of more than 12 percent from their peaks earlier this year, investors are uncertain about what direction the economic winds are blowing. But behind the blizzard of red numbers is a fundamental truth of global stocks: After a six-year bull market, which has lined investors' pockets with nice returns and fat dividends, the recent global sell-off isn’t an economic Armageddon. It’s simply what everyone knew was coming.
“This is not a new financial crisis like 2008. It’s a stock market correction,” said Mauro Guillen, director of the Joseph H. Lauder Institute of Management and International Studies, at the University of Pennsylvania's Wharton Business School. “If investors remain calm and will stay the course, they should be fine.”
A correction is widely defined as a drop in a market of at least 10 percent from a previous peak. So far, that’s about where the U.S. indexes stand. The Dow Jones Industrial Average has fallen 13.07 percent from its May 19 record high. The S&P 500 has lost 10.78 percent while the tech-heavy Nasdaq has lost 12.78 percent from the peak both markets hit on July 20.
That's nowhere near the 20 percent drop that most economists consider the gateway to a bear market, which is a prolonged downturn that can last months. And a market crash like the one that occurred on Oct. 19, 1987, sending the Dow Jones Industrial Average plummeting nearly 23 percent in one day, isn’t even on Wall Street's radar.
“This is more likely a correction that will last a few months,” said Sun Won Sohn, professor of economics at California State University. “The stock market always goes down faster than it goes back up, but I don’t expect the correction to take long, because the U.S. economy is fairly solid and corporate profits have been good.”
Unlike crashes, stock market corrections occur quite regularly. The last time U.S. markets dropped by more than 10 percent from their previous highs was in October 2011; before that, July 2010. Meanwhile, the last two times U.S. markets turned bearish by falling 20 percent or more was in March 2009 and October 2002. Economists say bear markets occur on average roughly once every 3.5 years, according to Capital Research and Management Company, based in Los Angeles.
While markets may be in a months-long correction cycle, experts admit China's economic slowdown is having a profound affect on the global economy. The Chinese economy, with a GDP growth rate that's expected to drop from 7.4% to below 7 percent in 2015, been slowing from the late 2000s. The World Bank estimates that China's growth deceleration began in 2010. Now, markets are reacting to new evidence in recent weeks that the slowdown in China is more severe than expected and substantially lower than Chinese government estimates.
It's not just Chinese businesses that are cutting back. Chinese consumers are destined to ratchet down their spending, too. “The decline in China has been really steep,” says Guillen. “A lot of Chinese households have been borrowing to invest in the local stock markets. And now Chinese families are in a bind. What happens in China today is more important than just 10 years ago.”
If China’s economic slump worsens, U.S. markets could wind up shifting from correction mode to an all-out bear market. But so far, economists are saying: Keep calm and carry on.