Will 2014 Bring A Stock Market Correction?
NEW YORK ( MainStreet) After an unusually high melt-up in stock prices last year, investors are bracing for more volatility in 2014 and a potential markets correction, defined as a 10% drop in a major stock market index.
The bears took control of the markets towards the start of 2014, with the Dow Jones Industrial Average and the S&P 500 falling 5.3% and 3.6%, compared to overall gains of 27.5% and 32% in 2013, respectively.
The sell-off continued into the beginning of February, leaving the first five weeks of 2014 with a 7% decline in equities. This fueled investor worries of a correction.
The declines in early 2014 came from volatile currencies in emerging markets, which have been hurt by the Federal Reserve's recent scale back of its bond stimulus, known as tapering. Investors fled emerging markets, opting to invest in safer U.S. securities, especially U.S. Treasury Bonds, which are expected to see a rise in yields as the Federal Reserve continues to taper.
The markets are also long overdue for a correction. The markets slumped just under 10% in spring 2012, but the last major correction occurred in summer 2011.
"Last year, we had a strong market advance with low volatility," says Gary Thayer, chief macro strategist at Wells Fargo Advisors. "It's seldom that we get two years in a row like that."
While the markets tiptoed near the 10% correction line in early February, stocks recovered, thanks in part to more certainty from new Federal Reserve Chairwoman Janet Yellen, whose first Congressional testimony in mid-February sparked a stock rally.
"The emerging markets selloff was a pullback, rather than a full correction," Thayer adds. "We haven't had one in two years, so we can't assume we won't have another one this year."
To illustrate the volatility in the markets, investors rely on the Chicago Board of Options Exchange Volatility Index (VIX), which uses the options market to gauge volatility over the next month. The VIX soared over 34% in January, indicating increased volatility, compared to 2013's overall decline of 39.6%.
While it's difficult to trade in and out of a correction, which can last for months, long-term investors can benefit from corrections, as lower stock prices present attractive buying opportunities.
"In a correction, you would expect investors to be more cautious," Thayer tells MainStreet. "Over the past few weeks, as markets recovered, we've seen investors flock to defensive stocks, rather than cyclical."
Consumer discretionary stocks performed well in 2013, but have faced more turbulence in 2014. On the flip side, Thayer says the utilities and health care sectors tend to have less volatility and bode better for weathering a correction.
"I don't think anyone can correctly anticipate when a correction is going to happen," Thayer adds. "We advise staying the course and viewing corrections as a time to consider buying."