For nearly two years, investors have enjoyed almost uninterrupted growth in the stock market. So it’s been easy to forget that short-term stock price fluctuations are normal.
Until the S&P 500 index, which tracks 500 large stocks, slipped last week, it had been more than a year since the index had even fallen 5 percent—which was a record. Such pullbacks are usually a pretty regular occurence.
Even veering later in the week into “correction” territory isn’t that unusual. Market corrections, defined as a 10-percent price decline from the 52-week high, have happened on average about every year and a half, according to a Deutsche Bank report. Since 2010, there have been four other corrections.
“When the market declines sharply, everyone naturally wonders, 'What’s wrong?' Nothing is wrong economically. The economy is doing better now than it has any time in the past decade,” noted Greg McBride, Bankrate.com's chief financial analyst, last week. “This is just some healthy, and overdue, volatility to wring out any excess.”
The market has been growing at such a fast pace, in fact, that the latest drop in the S&P 500 index only erased the gains of the last few months. “We’ve just given back some recent gains, not wiped out anyone’s life savings,” McBride emphasized.
So, what caused the pullback? And what’s next?
Well, no one knows for sure where stock prices will go next. Sometimes a pullback is just a temporary blip, while full-blown corrections have lasted a few months, on average. But by Friday, the market had already begun to recover—and it continued the general upward trend this week.
There were a number of factors that could have set off the initial decline. Some major names like Exxon Mobil—one of the world’s 10 largest companies and a big component of the Dow Jones industrial average, an index of 30 of the biggest U.S. stocks—reported lower-than-expected earnings, and their stock prices fell as a result. That dragged down the index as well.
When major indexes start falling, that can scare some investors into panic-selling—never a good idea, as it locks in your losses and may keep you from fully benefiting as the market recovers. That can also add momentum to a dip.
Another potential factor is rising interest rates. The Federal Reserve, the country’s central bank, is now expected to raise rates at least three times this year. That means higher borrowing costs for companies (and for regular borrowers like us, too) and can hurt a company's stock price if it's borrowed a lot. Since the interest it’s paying on that debt is more expensive, more money will be spent paying it down, leaving less for product development, marketing, and other investments.
Higher interest rates also affect the interest paid on bonds, making them more compelling to investors. Existing bond prices generally fall after the central bank raises rates, and newly issued bonds tend to offer higher interest rates to attract buyers. Since bonds are generally considered to be less risky, and a higher interest rate generally increases demand for bonds, the thinking is that that may hurt demand for stocks.
While it’s not clear how much any one factor affected the recent drop in stock prices, analysts agree that such declines are completely normal—and a pullback was likely overdue.
What should you do now?
Stay calm and avoid any emotional, knee-jerk response to the market’s movements. Remember, over history, every single U.S. stock market downturn has ended in an upturn. When you look at it that way, drops like this aren’t so dizzying. ‘’With such strong economic and earnings fundamentals,” notes McBride, “each dip is a buying opportunity.”
This article has been updated to reflect market developments.