For those breathing a sigh of relief after the stock market enjoyed a rebound Tuesday, the bad news is this sell-off probably isn't over yet.
The historical data is a reminder that the stock market may get worse — or at least go sideways — for a while. But it also confirms what many longtime investors will tell you: Don't panic. After a massive rise in stock values, this is probably pretty healthy.
“I don’t think the decline is over,” said Kristina Hooper, chief global market strategist at Invesco. “Valuations are still stretched.”
The Dow was up about 26 percent from January 2017 to January 2018, an increase that is over three times the typical annual gain of 8 percent. It's why just about everyone was saying that we were overdue for a correction.
On top of that, some individual stocks were especially turbocharged. Netflix, for example, was up over 40 percent in January alone, and Boeing jumped over 20 percent last month. Even after the pullback, Netflix and Boeing have only given back about 5 percent of the massive gains.
"We had stocks that had moves in January that you just can’t sustain every month," said trader Tim Anderson, a managing director at MND Partners.
The market isn't exactly cheap yet, but it's a lot closer to normal pricing than it was. A popular gauge of how expensive the market is -- the “P/E ratio” -- looks at stock prices divided by expected earnings. The P/E ratio was 18.2 before the recent decline. Now it's 16.9.
The historic average P/E is about 16.5, which suggests there might be a bit more to give back.
Technically speaking, we haven't even had a true correction yet.
A correction happens when the stock market falls at least 10 percent from its prior high. The most popular stock market indexes — the Dow, S&P 500 and Nasdaq — all hit records on Friday, Jan. 26. On Tuesday morning, the Dow briefly traded down 10 percent from that Jan. 26 high, but then it rebounded and ended up closing well above a correction.
The S&P 500 and Nasdaq still haven't hit correction territory, not even temporarily.
“From a technical standpoint, no we haven’t hit that correction yet,” said David Lebovitz, global market strategist at JPMorgan Asset Management. But he argues that because 2017 was such a calm year in the markets, what we just experienced felt like a correction.
Hooper of Invesco has dubbed it a “flash correction” since it happened so fast.
We've only had three days of selling. Since 1945, the typical length of a correction is 71 trading days — or about 2.5 months, according to MarketWatch. The last correction started in the summer of 2015 and lasted about half a year.
It's still possible we could see the market close in correction later this week or month.
“I think we are closer to the end than we are to the beginning, but it’s not time to sound the all clear,” said Lebovitz.
Here's what to watch for going forward.
First, have the economic fundamentals changed? Overall, the U.S. economy still looks very healthy. Unemployment is low. Consumers and companies are opening their wallets and spending. The economy is growing, and inflation, which supposedly scared investors, is still just 1.7 percent (lower than the 2 percent inflation target the Federal Reserve has). The main worry is that the economy might overheat and the Federal Reserve might make a mistake and raise rates too quickly, but none of that has happened yet.
The market will be watching the incoming data closely in the coming weeks, especially on wages and growth.
Second, have the corporate fundamentals changed? Companies are reporting very strong earnings lately. Some companies such as Amazon and Apple have even had record quarters. The recent tax cuts are making companies more profitable and lifting sentiment among many business owners. Overall, companies seem to be in great shape, but some stocks are still pricier than others.
Investors will be watching for stocks that are gaining or losing too much, like what happened in January.
Finally, watch for more “flash crashes.” The other factor to pay close attention to is whether there are more super-fast drops like what the market saw Monday at 3 p.m. when the Dow shed about 1,000 points in a matter of seconds. Most blame computer trading for that rapid decline. Humans simply can't trade that fast on their own.
It appears a lot of those computer “technical trades” have been made, but they could easily pop up again if the market starts to fall quickly later this week or month. Keep an eye on those movements. It's a sign more factors at work than just the “fundamentals.”
“These computerized selling models are written by people who don’t understand all the mechanics of the market,” said Anderson of MND Partners.