US markets turmoil: Why this is a correction and not a crash

US markets turmoil: Why this is a correction and not a crash

US markets turmoil: Why this is a correction and not a crash

Updated 9 February 2018, 13:35 AEDT

The current market falls are a big wake-up for investors used to green lights and upward lines.

It was only a couple weeks ago that America's Dow Jones and S&P indexes were at record highs.

That feels like a long time ago now. After a terrible week, the US stock market is down 10 per cent from where it was on January 26, and the ASX is feeling the aftershocks.

It's a big wake-up for investors who were getting used to green lights and upward lines. But don't worry, it's not a crash (yet, anyway). Here's why.

Currently, we're in 'correction' territory

It's a pretty tame word when you put it alongside the headlines we're seeing at the moment — "plunge", "wipe-out", "smash", "dive", "plummet", "crash".

But here's what it means, according to Investopedia:

"A correction is a reverse movement, usually negative, of at least 10 per cent in a stock, bond, commodity or index to adjust for an overvaluation.

"Corrections are generally temporary price declines interrupting an uptrend in the market or an asset."

So what we're seeing now would appear to be a textbook example.

The good news is that corrections like this aren't the end of the world for your superannuation account. As the ABC's Stephen Letts wrote earlier this week:

"Corrections like this are generally a small step back on the long march forward. Negative annual returns are pretty rare."

In fact, corrections are fairly common — they happen on average once a year on the Dow Jones, according to US fund manager Grayeli Investment Management.

However, while there are reasons not to get too worried, there's still no way of knowing whether the current correction could become a "bear market" or a crash.

It would become a bear market if it dropped 20 per cent or more from its recent high

Bear markets are far less regular than corrections, and far more worrying.

Bank of America Merrill Lynch calculates that there have been 25 bear markets in America since the biggest one of them all in 1929 at the start of the Great Depression. And 10 of these bear markets occurred in the decade after 1929.

The most memorable bear market of recent times was the global financial crisis, when the Dow Jones dropped more than 50 per cent between October 2007 and March 2009.

The ASX was in bear market territory as recently as 2016, and before that in 2011 off the back of the Greek debt crisis.

Crashes are as much about the speed of the fall as the fall itself

"I guess a crash is a bear market on speed," is how Letts defined it.

There's a psychological aspect to crashes, as people join the rush to get out of the market, fearing that things are only going to get worse.

We might have seen a glimpse of that on Wall Street this morning, where there was a sell-off in the final hour of trade.

It's far too early to start talking about recession

While decline on a stock market can point towards a coming recession, they are really measuring different things — recession simply refers to two consecutive quarters of GDP decline.

As economics editor Ben Chu from The Independent points out, the stock market is not the economy:

"Stock markets can boom when GDP is stagnant, when wages are flat, when living standards are going nowhere. And they can fall when economies are picking up speed and life, for many people, is getting better. The latter actually describes the current situation."

To put the recent falls on the Dow Jones in perspective, they were sparked by wage growth in the United States, which many economists would argue is a positive.

The global economy is expecting 4 per cent GDP growth for the year, and the last measures we have for the US and Australia respectively are 2.6 per cent (fourth quarter 2017) and 2.8 per cent (third quarter 2017).

Because there won't be a quarter of negative GDP in Australia or the US in the first quarter of 2018, things would really have to unravel for the rest of the year for us to get into recession territory.