10% Corrections and a Look at 1966

With the S&P 500 set to open lower this morning, it looks like the 10% correction threshold will be met.  This would make the period from 3/11/03 to 7/19/07 the second longest since 1940 without a 10% correction.  We looked back at all periods of 1,000 calendar days or more since 1940 without a 10% correction to see how much the market went down once we did break the -10% barrier.  As shown below, there have been three such periods and in two out of three, the S&P 500 moved into a bear market (-20%).

We also searched the Google News Archives for what was going on at the end of the 1966 rally (start of the 1966 bear market), and we found a Time Magazine article titled Overreacting that was published 23 days after the market peak.  The market was just starting to reel from a startling "shortage of investment money" and the Vietnam War.  The argument from the "overreacting" camp was a strong economy and strong valuations.  Excerpts from the Time Magazine article are provided below:

This week the U.S. enters what promises to be its sixth straight year of economic expansion, and almost everything is rising—except the stock market.  It has been falling since early February, and last week Wall Street's bull was still reluctant.

Measured by the important price-earnings ratio, stocks are lower than they were at the low point of the 1962 break.  They are now selling at an average 16.3 times expected 1966 earnings, compared to a 17-to-1 ratio in the bleak summer of '62.

Prices are low because worries are high, and investors are reacting—probably overreacting—to the economic implications of the Viet Nam war.  They are afraid of higher taxes and more controls on the economy, perplexed by the squeeze on credit and pressure on profit margins. 

Some of the stock market's troubles stem from a worsening shortage of investment money. Salomon Bros. & Hutzler, a leading bond-trading house, predicted that commercial banks will have $3 billion less to put into long-term credit this year than last.  With a swiftness that startled even investment men, the money shortage has driven interest rates on some new bond issues to 45-year peaks, prompting investors to sell stocks in order to buy bonds.  Last week $40 million of Long Island Lighting Co. bonds went on sale with a 5.13% interest return, one of the highest yields ever placed on a corporate issue of its type.  The Federal National Mortgage Association had to pay a record 5.38% to sell $250 million of 14-month debentures.