The supplied chart highlights the frequency of stock market
corrections. Annual percentage corrections in the S&P 500 are
shown in red while calendar returns for the S&P 500 are shown in
blue. The red dashed line (-16%) represents the average annual
correction since 1995. This means, on average, the S&P 500 has
experienced a 16% correction at some point during the year, each year,
since 1995. Notice there have only been six years where the total
return for the S&P 500 was negative since 1995 – three years in a
row after the dot-com bubble burst in 2000, 2008 where the S&P 500
experienced its largest loss (-37%), 2018 and 2022. For the other 24
years since 1995, investors made a lot of money buying the sell-off
during the year as the market finished with a positive return.
The logical question is what will be the case for calendar year 2025
– is the correction the market has experienced year to date a buying
opportunity or a harbinger of a larger sell-off? The answer depends on
the fundamentals which drive stock market performance, principally
earnings and economic growth. Average earnings growth estimates for
companies in the S&P 500 this year remain strong (greater than
10%) and earnings drive stock prices over the long term. However,
earnings estimates are just that, estimates, meaning they can be
wrong. The largest factor which could substantially change estimates
for earnings growth is the health of the economy. This is the reason
President Trump’s trade war is creating stock market volatility. A
prolonged global trade war would likely lead to a recession in Canada
and the U.S. which would mean earnings estimates for publicly traded
companies need to be revised lower. History has shown that “normal”
stock market corrections (24 of the 30 observations in the chart) are
distinguished from more significant market corrections (i.e. 2008)
based on whether the economy experienced a recession. Stock market
corrections are larger and more pronounced if they coincide with a recession.
Economists view the stock market as a leading economic indicator due
to its ability to efficiently discount information. Each public
company announcement and economic data release is priced into markets
shortly after its release which is what makes markets efficient over
the medium term. What makes the current correction unique is it has
been caused by President Trump’s trade policies. Said another way, the
current correction represents the market’s view on the probability of
recession – the market is estimating whether Trump’s trade policies
are a tactic for negotiating improved trade deals or whether they will
be longer lasting, leading to a recession. Have we already seen the
market bottom in 2025? It really depends on whether Trump opts to make
a deal or dig in his heels on his self-inflicted trade war.