Q&A: Stocks slide into another market ‘correction’

For the second time this year, stocks have gone into what's known on Wall Street as a correction—a drop of 10 percent or more from a recent high.

As of Friday's close, the benchmark Standard & Poor's 500 index has dropped 298 points, or 10.2 percent, since reaching a record high on Sept. 20. After a furious decline in October, stocks steadied in early November, but the selling picked up again the past two weeks as investors abandoned high-flying technology stocks amid concerns about the U.S.-China trade dispute and global economic growth and bailed on energy stocks as the price of oil plunged.

The Nasdaq, loaded with technology stocks, is already in a correction. The Dow Jones Industrial Average is 9.5 percent below its high set on October 3.

According to research firm CFRA, this is the first time since World War II that the S&P 500 has had two corrections in the same calendar year, though there have been a few times where it experienced corrections within 12 months of each other.

The stock market is still enjoying the longest bull market in history although some of the conditions that sustained it have changed, including an increase in interest rates to more normal levels after the Federal Reserve helped keep that at historical lows for years.

"Corrections are normal, but they haven't been normal during this period of the Federal Reserve bringing interest rates down to near zero for so many years," said Quincy Krosby, chief market strategist at Prudential Financial.

Here's a look at what history shows about past corrections, and what market watchers are expecting going forward.

Q: How bad is this market drop?

A: The latest drop isn't as breathtaking as the one in February, when the S&P 500 lost 10.2 percent in just nine days. Only 19 times since World War II has the S&P 500 lost at least 10 percent in 10 days or fewer.

Still, the return of volatile trading and the S&P 500's latest slide into a correction caught many investors by surprise. The benchmark index didn't record a single gain or decline of 1 percent or more in the third quarter.

That was similar to the calm seen in 2017, when the market drifted higher gradually and finished up 19.4 percent.

Q: What happened after the last correction?

A: The stock market recovered some losses then fell again due to uncertainty over global trade disputes. Eventually, investors focused on soaring corporate profits, fueled by the GOP tax cuts, and robust economic growth in the U.S. and the S&P 500 rose to an all-time high in September, erasing the losses from its correction in February.

Q: What's bothering investors?

A: Many investors are increasingly worried that corporate profits — which drive stock market gains — are poised to weaken.

Profits have been extremely strong this year—earnings for the S&P 500 are estimated to have risen by 28.6 percent for the third quarter after a 25.2 percent gain in the second quarter.

But an array of threats to company earnings has emerged in recent months: Interest rate hikes by the Federal Reserve. A Trump administration-led trade war. And there are increased signs the global economy is slowing — for instance, growth in China has weakened and the German economy had its first quarterly decline since early 2015.

That has made investors nervous about the valuations of some of the market's high-fliers. Apple and Amazon issued disappointing outlooks in October, and both stocks are down more than 20 percent this quarter. Caterpillar and Boeing, two industrial powers that stand to be hurt by a prolonged trade war between the U.S. and China, have also suffered sharp losses.

Q: How bad can it get?

A: In truth, no one knows.

But some analysts say there are more hurdles for the market now than there were at the onset of the last market correction in February. Back then, companies had yet to show the positive impact tax cuts would have on profits and the U.S. and China hadn't imposed costly tariffs on each other.

The U.S. economy grew at a healthy 3.5 percent annual pace from July through September; annual growth was an even stronger 4.2 percent in the second quarter. The two periods marked the strongest consecutive quarters of growth in four years.

There is some concern, however, that the Federal Reserve could overshoot with its campaign of interest rate increases and eventually slow the economy too much.

The Fed has raised its key short-term rate—a benchmark for loans throughout the economy—three times this year. And it's expected to do so again in December and at least twice in 2019. Rising rates make borrowing costlier for consumers and companies.

"Now that the Fed is normalizing rates, the market is doing what it historically does: Reprice according to perceived conditions. And right now, the market is focused on the tariffs issue and on how far the Federal Reserve moves toward rate normalization, and also concerns of slowing global growth," said Prudential's Krosby.

Q: Given their drop, are stocks cheap now?

A: The market is cheaper, but not necessarily cheap.

Analysts look at several measures to gauge how expensive stocks are, and many of these measures are lower than they were a couple weeks ago but still above their long-term averages.

Consider how much stocks cost relative to how much profit they produce, one of the most commonly used measures. The S&P 500 trades at 15.2 times its expected earnings over the coming 12 months, for example. That's a more attractive price-to-earnings ratio than the 17 it sported a month ago, and it's much more palatable than the price-to-earnings hratio it had of nearly 19 when stocks were surging in January.

But the market remains more expensive than its average of 14.7 over the last 15 years. And it's nowhere close to how cheap it was in the depths of the financial crisis, when the S&P 500 was trading at less than 9 times its expected earnings.