Why a 10% Stock Drop Will Feel Like a Bear Market to Investors

Investors have gotten so used to a stock market in which prices climb upward with few significant retreats, that a long-overdue correction of 10% or so may induce widespread panic. "Investors fear they're going to get caught holding the bag if you get that inevitable 10% correction," according to Larry Glazer, co-founder of $2.5 billion investment management firm Mayflower Advisors LLC, in remarks on CNBC. He noted that, in the midst of last week's market decline and increases in volatility, "We had investors saying to us 'Is this it? Is this the big one?' So, investors are not conditioned."

Correction Underway?

The last correction of 10% or more occurred in August 2015, per CNBC. While seasoned investors should shrug off such a pullback as "really just a day in the park," for those who lack this long-term perspective "it's going to feel like 20 or 25%," Glazer added.

Well, it appears that a long-delayed correction finally may be underway, and investors are getting increasingly nervous. After gaining 7.5% for the year-to-date through January 26, achieving a new record close in process, the S&P 500 Index (SPX) has retreated 7.8% since then, giving it a net loss of 0.9% for the year-to-date through the close on February 5. With the Dow Jones Industrial Average (DJIA), the figures are similar: up 7.7% through January 26, down 8.5% thereafter, and down 1.5% for the year-to-date through Monday.

It's All Relative

With the major stock market indices just off all-time record highs, a given point decline in absolute terms is equating to a smaller percentage drop. For example, the Dow shed 1,175 points on February 5, for a 4.6% decline. The 113 point drop in the S&P 500 on the same day equated to 4.1%.

Just two years ago, 1,175 points equaled 7.3% on the Dow, and 113 points on the S&P 500 represented 6.0%. Go further back, to the previous bear market lows reached in midday trading on March 6, 2009, and these same point drops would have translated into 17.7% on the Dow and 16.5% on the S&P 500, respectively.

Bear Market Today = Bigger Point Drops

Real pain would be induced by an extended bear market, in which stocks drop by 20% or more according to the standard definition. The last bear market ran from August 2007 to March 2009, lasted 571 calendar days, and knocked 56.8% off the value of the S&P 500 Index (SPX), according to Yardeni Research Inc. Given this recent precedent, a decline of 25% is entirely possible.

From the Febuary 5 close, a 25% drop in the S&P 500 would equate to 662 points, versus 470 points two years ago, and 167 points at the low point of the previous bear market in March 2009. The same percentage decline in the Dow would equal 6,086 points today, 4,051 two years ago and 1,657 in March 2009. Note that the respective bear market lows of both indices were 666.79 and 6,469.95, close to the point values of 25% declines today.

Casino Mentality?

Other observers echo Glazer's concerns that investor psychology today seems unsuited to riding out a 10% correction, let alone a 20% bear market plunge. Perhaps it's an issue with neophytes who became investors during the current bull market, or perhaps too many experienced investors have forgotten the subprime meltdown, the 2008 financial crisis and the last bear market, let alone the 1987 stock market crash or the 1929 crash. Worse yet, there are numerous indicators of a growing casino mentality in the markets that contrarians would take as bearish signals. (For more, see also: Why The 1929 Stock Market Crash Could Happen In 2018.)

Discount brokerage firms have reported a rush of new account openings by what appear to be first-time individual investors, The Wall Street Journal reports. Driven by greed and outsized expectations late in the bull market, many of these inexperienced players are buying into the market when valuations are frothiest, and the opportunities for future gains are thus diminishing. Some of these new investors, the Journal notes, already have ridden the cryptocurrency or cannabis investing crazes.

Momentum investing is becoming increasingly popular, as investors chase hot stocks regardless of the fundamentals, in the unduly optimistic belief that what goes up will continue to levitate. Meanwhile, discount brokerage firm TD Ameritrade Holding Corp. (AMTD

) has introduced 24-hour-a-day, 5-day-a-week online trading of several popular ETFs, and indicates that round-the-clock trading of popular individual stocks, such as the FAANG tech giants, may be around the corner, CNBC reports. (For more, see also: Why Stock Investors Play the Risky 'Momentum' Game.)

Crowded Exits

As all these new players jump into the stock market, with unrealistic expectations about future gains, and no patience or stomach for riding out downturns, the exits could get rather crowded once a true correction gets underway. It could get very ugly, with a frenzied stampede to sell sending stock prices plummeting downward. (For more, see also: Stock Shock! Why Your Returns May Plunge By Half.)

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