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Wealth Column: The difference between a stock market correction and a full-blown crash

Earlier this year, anyone with money in the stock market was likely feeling a pinch after watching the S&P 500 drop by over 300 points in February.

Earlier this year, anyone with money in the stock market was likely feeling a pinch after watching the S&P 500 drop by over 300 points in February.

And then after a brief recovery period, we saw the markets take another hit in March, which led many investors to become concerned that we were on our way to yet another stock market crash.

But what exactly is a stock market crash and how is it different from a correction?

The answer is that in general, it's subjective. When we talk to clients about the stock market, many of them remember the Great Recession of 2008 and 2009 or the bear market we experienced starting in 2000. In those situations, people saw their 401(k) become a 201(k) as the value of their stock portfolios were cut in half. A more objective way to talk about these instances is that they resulted in a bear market, which we describe as being a dip of at least 20 percent in the value of stocks.

On the other hand, we generally refer to a correction as a period where the stock market drops by 10 percent of its value. This is what we saw happen in early 2018. In the past 20 years, the S&P 500 Index has experienced ten such corrections. This demonstrates that in fact, these market corrections are a fairly common occurrence. The even better news, all but two of those such corrections recovered their losses within six months. And the two that didn't were in 2007 and 2000, which turned into the bear markets we discussed earlier. And yet, even those situations, the market recovered after a period of three to four years.

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Should we be prepared for another bear market soon?

While we believe that people should always prepared for volatility through diversification and risk management, we don't expect a stock market crash to occur in the near future. That's because other measures of the economy are still holding strong, like employment rate and direction of the global economy. Currently, the U.S. is at full employment, or some would even say over-employment, with the U.S. unemployment rate reaching a 10-year low of 3.8 percent as of May 2018. Aside from strong jobs numbers, we are also seeing strong trends in the global economy. Thanks to trade and globalization, markets in other area of the world can affect U.S. markets as well. Positive growth around the world tells us that a global financial crisis is not on the horizon.

However, as we mentioned earlier, it's still important to be prepared in case of a market correction, or a bear market in the future. While we don't believe there is reason to panic about a steep drop in stock prices, we do believe that being prepared is important. In order to do that, we suggest you speak with an adviser about how to properly position your investments so that you can weather a financial storm.

Related Topics: MARKETS
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