Market Corrections Profile

July 2008

To objectively assess whether market corrections have natural changeover points...percent changes carrying implications for emerging trends...we compile a profile of all corrections and their aftermath.

Tabulate the Data.  The panel below tabulates completed S&P 500 corrections from 1972 to July 2008. A correction is defined to begin with any decline from a historic high, and is "completed" when the index has recovered the entire loss and posts a new high.  The top data line of the panel, for example, says there have been 125 declines of less than 1% in the study period, comprising 50.2% of all pull-backs of any magnitude.  The second data line says there were 42 declines of 1% or more but less than 2%, and (in the final column) that drops of any size up to 2% comprised 67.1% of all pull-backs. Thus, 32.9% of corrections were 2% or greater.

Downside Continuations.  The "Prob Continue" column shows the mix of all declines greater than the given (row) drop as a proportion of all equal or greater declines.  For example, in the third row, of all declines that reached the -2% to -3% range, 69.5% continued at least somewhat lower than -3% (so 30.5% stopped at no more than -3% and recovered to new highs).


The 4th column ("Prob Continue") shows that once a  correction greater than 1% is underway, the probability is greater than 50% for downside continuation of some additional decline in every case (aside from the final, 50% drop of course). 

Strange Attractors.  Also in the 4th column, there are two "cusps" of abnormally high frequency of downside continuation;

Declines of -3% to -4% show 84.2% continuation
Declines of -8% to -9% show 93.3% continuation

These two probability cusps suggest a possible "attraction to round numbers" effect as the S&P approaches declines of 5% and 10%.  Such effect might result from open orders (or intentions) to buy only when the market drop has reached such points. 

Bear Threshold.  Also notable is the "gap" of no occurrences from -20% to -27%.  This gap (and the sparseness below it) represents an unexplained, but nevertheless apparent "bear market" effect; when an S&P decline passes 20%, more is in store.  Either it's a symptom of a larger problem unfolding, or perhaps the accompanying media attention shifts investor intentions.  In either case, additional market setback is likely until there is evidence to the contrary.

Click Threshold for analysis of S&P decline extent after falling 20%.

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