This article was written on 10 April 2025
The human brain responds more to feelings than facts. This can get in the way of good investment decisions. So, a sensible thing to do after the week we’ve just endured is to park our emotions and go in search of the numbers.
Step one in navigating a stock market correction is to put it in a historical perspective and decide what is really going on. How do the current market moves compare with similar episodes in the past?
Between the financial crisis and the latest correction, there had been four drops that met the usual definition of a bear market - a 20 per cent decline. The first, in 2011, saw a 22 per cent fall in five months. The next, in 2018, was a 20 per cent drop in 11 months. The start of the pandemic in 2020 was deeper and faster - a 33 per cent fall in just over a month. In 2022 the MSCI World index fell 27 per cent from January to October.
So, the latest fall of 16 per cent from the February high has been notable for the pace of the decline - which brought back memories for some of us of the 1987 crash.
Step two is ascertaining what caused the fall. This is not always simple. The current slump has had multiple triggers. It began with a rotation out of the US in response to excessive valuations. But latterly the focus shifted to growth and inflation fears, exacerbated by erratic and (the market concluded) illogical policy making. There are echoes of previous corrections here - a reminder that market history never repeats but often rhymes.
The third part of the classification process is to look at where the market pain is being felt. Share prices can fall for a whole host of reasons and by themselves tell you little. A stumble in the corporate bond market, with investors demanding an increasingly higher yield from companies than governments, can be a better signal of distress in the real economy than a sentiment-driven stock market wobble.
Elsewhere, if traditional havens like government bonds fall when you might otherwise expect a flight to safety, this can be a sign that over-leveraged investors are struggling to lay their hands on cash - a liquidity red flag. Same story with gold, which usually rises on uncertainty but can fall if overstretched investors are selling what they can rather than what they would choose to.
We know that shares have fallen hard and fast. What about the other measures? Corporate bond spreads have widened since the start of the year, but they have only returned to the historical average. More worryingly, this week saw the fastest rise in the yield on the 30-year US Treasury bond since the start of the pandemic. This has raised the possibility that big holders of Treasuries such as the Chinese are weaponizing their holdings, deliberately selling to destabilise the financial system and force a policy U-turn on the US. Finally, gold fell for four consecutive sessions from its all-time high from last Wednesday to Monday. There are certainly signs of stress, but they are not yet flashing red.
The final piece of context is whether or not we are heading towards a recession. This matters because bear markets tend to be more severe and to last longer if accompanied by a recession than if they are triggered by some kind of one-off shock that does not lead to an economic downturn. The current market turmoil feels more like the event-driven type of correction. Activity is slowing but it’s not yet clear if we face a full-blown recession. Our figures suggest a 40 per cent chance but a slightly higher likelihood of stagflation - sluggish growth coupled with persistent inflation.
The next job for someone deciding whether to jump back into the market or stay on the sidelines is to check in on fund flows, earnings, and valuations - the fundamental investment measures. So, how severe has the selling pressure become? One measure of this is the percentage of companies that are now trading below their recent average price. Typically, investors look at this over a 200-day period. Only a quarter of big US stocks are now above that 200-day moving average price - in 2018, this fell to 16 per cent, 12 per cent in 2022 and just 3 per cent when Covid struck. So, shares are starting to look oversold, but it seems we are not yet in a clear buy zone.
When it comes to the most commonly used valuation measure, which compares share prices to earnings, it’s another case of ‘move on, nothing to see’. The ratio of price to earnings in the US has fallen from 26 to 21 which means the market is no longer expensive but not obviously cheap either. With the first quarter earnings season due to kick off tomorrow, the focus will be on just how long profits can keep growing in the face of the tariff squeeze. Earnings are still forecast to grow about 10 per cent year on year. Frankly, that would be a good result. I expect some cautious commentary from companies over the next few weeks.
The past week has been a cold shower for investors, but it really only takes markets back to where they stood shortly before the architect of all this volatility won back the keys to the White House in November. It’s worth noting that while the MSCI World index is 16 per cent below its recent peak it is 36 per cent above its level in October 2022. To have benefited from that two-and-a-half-year gain, you would have had to be fully invested at a time when the market had just fallen by more than a quarter from its prior peak and sentiment was very weak. To do that would have required a focus on facts not feelings, and the same holds true today.
Tom Stevenson is an investment director at Fidelity International. The views are his own.
