Stocks: How often does a ‘correction’ become a bear market?

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Stocks’ brutal sell-off on Thursday pushed most major market indexes into “correction” territory -- meaning, a drop of more than 10% from their recent highs.

The Standard & Poor’s 500 index (charted below) plunged 4.8% for the day and is down 12% from its 2011 high reached in April.

If the selling goes on, and the S&P and other indexes fall more than 20% from their highs, Wall Street will declare that a new bear market has begun.

So how often does a 10% correction lead into a bear market?

Market research firm Birinyi Associates in Westport, Conn. looked at the 10%-or-greater pullbacks in the S&P 500 since 1962. That period encompasses 10 bull markets.

There have been 25 declines of 10% or more since 1962. Nine of them turned into bear markets, meaning the S&P went on to fall more than 20%, Birinyi found.

In the other 16 instances the S&P’s losses halted between 10% and 20% and the market began to move higher again.

The last correction occurred from April to July 2010, when the S&P fell 16% before bottoming. It began to resurge last fall when the economy improved and the Federal Reserve signaled that it was ready to pump more money into the financial system.

So if post-1962 history is a guide, “There is a 64% probability that this is only a correction and not the start of a bear market,” Birinyi analysts Kevin Pleines and Jeffrey Yale Rubin said in a report.

Birinyi has been bullish on stocks and isn’t changing its mind now. “Our view remains that we are in a long-term bull market and in long-term bull markets you have downdrafts,” Pleines and Rubin wrote.

Still, the U.S. economy is in far different shape this time around than it was during the corrections and bear markets before 2008. Excessive debt at the government and consumer level is weighing heavily on the economy, keeping it from achieving “escape velocity” from the last recession.

Even if the U.S. can avoid another deep recession, the question is whether many investors will be willing to hang onto stocks if they increasingly believe that the recovery is a dud and has no hope of turning into anything better soon.

-- Tom Petruno

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