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The pullback in stock markets over the past month has been greeted with much consternation among market watchers. The sudden downturn in the 10-month-old rally - which has, in short order, shaved 7 per cent off the S&P/TSX composite index and 8 per cent off the S&P 500 - reawakened some nagging doubts about the sustainability of those heady gains the markets have enjoyed since last March.

Is this a sign of the cracks surfacing in the economic recovery? Was the 2009 market rally a massive mistake that the markets need to correct? Are risk and volatility about to return, bringing the market roller coaster back with them?

Relax. Take a deep breath. Market corrections of this calibre - and more - are perfectly normal in the year following the end of a recession. In fact, they're generally pretty healthy for stock rallies.

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"It is important to keep in mind that equity pullbacks are part of every economic recovery," wrote Stéfane Marion, chief economist and chief strategist at National Bank Financial, in a recent research note.

Indeed, the markets have featured a significant pullback in every post-recession year in the past 40 years. These pullbacks have averaged about 13 per cent for both the S&P/TSX composite and the S&P 500.


Those numbers have been inflated by the huge declines in the bursting of the dot-com bubble in 2001-2002.

But even if you exclude that recovery year, the S&P/TSX has suffered a pullback averaging more than 10 per cent in the year after the recession's end, while the S&P 500 has seen corrections averaging almost 9 per cent.

In most cases, the corrections were just that - short-lived consolidations that were followed by the continuation of a longer-term rally.

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And logically, such corrections make perfect sense; the markets, having generally anticipated the start of the economic and earnings turnaround, take a breather once much of the good news gets priced in - settling into the reality of the recovery and setting up for the next leg of economic and market expansion.


However, there were two exceptions to the recovery-year trend.

The big one was in 2002, when the markets were mired in a nasty bear for most of the year. That's because despite the economic upturn of that period, the markets were still working off the excesses of their tech bubble - a problem Mr. Marion doesn't see repeating itself in this recovery.

He noted that at the end of the 2001 recession, the S&P 500 was still trading at a relatively bloated price-to-earnings ratio of 21 times its forward 12-month earnings. Right now, he said, the S&P 500's forward P/E is a historically reasonable 14 times.

"As such, we would not expect to see a larger-than-average recovery pullback in the coming months," he wrote.

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"The improving economic backdrop remains supportive of equities."

But the other exception to the trend proves the significance of the last part of Mr. Marion's comment - without sustained support from the economy, a correction in a recovery year can turn into a new bear market.

The 10-per-cent pullback in the 1980-1981 recovery year was just part of a general downward slump in the markets, which never quite embraced the economic turnaround.

As it turned out, that "turnaround" proved unsustainable - the false start in the now-infamous "double dip" recession, as the economy went back into contraction by the middle of 1981.


Current pullback within the norm

Market dips are typical following the end of recessions, says National Bank Financial. And given the relatively cheap P/Es in the current market, the bank's not expecting any larger-than-average pullbacks in the months ahead.

End of Recession Date

Largest pullback in the 12 months after the end of the recession

Largest pullback in the 12 months after the end of the recession

S&P TSX returns

S&P 500 Returns

November 1970



March 1975



July 1980



November 1982

- 9.2%


March 1991



November 2001



July 2009 *



AVG. (EX.-2009 )



AVG. (EX. 2009 & 2001)



*estimated recession end

**to date


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