What really drives market corrections?
Even the strongest bull markets don’t move in a straight line.
Prices surge, they pause, they retrace – sometimes in quick pullbacks that last a few weeks, other times in grinding corrections that drag on for a year or more.
Corrections are not random crashes; they’re part of a process. And like any process, they come in all shapes and sizes.
The key to understanding them isn’t just looking at the headlines or the latest scare.
It’s recognizing the role of time horizons.
Structural vs Tactical
When we talk about market moves that last for several quarters or even years, we’re talking about structural trends.
These are the big-picture forces at play – the kind that drive U.S. equities higher over a decade, push gold into multi-year cycles, or reshape interest rates over generations.
Inside those structural trends live the shorter-term cyclical, or tactical, trends. These are the swings that play out over a few weeks to a few months.
More active investors focus here, looking to take advantage of tactical opportunities, while passive investors usually ride the broader structural waves.
Think of it like this: the structural trend sets the direction of the tide, while the cyclical trend is the wave action on top of it. The waves can be choppy and disruptive, but they still move within the broader pull of the tide.
We can’t predict every twist and turn in the short term, of course. But what we can rely on is that asset prices trend – and the structural forces shaping those trends are much stronger than the tactical noise.
That’s the concept that we want to make sure we understand.
It’s a Market of Stocks
When you study past market corrections, one pattern becomes clear: Before the major indexes roll over, the weakness usually shows up first beneath the surface.
Individual stocks, sectors, and industry groups begin deteriorating well in advance.
This “breadth deterioration” has preceded many of history’s worst sell-offs, including the tops in 2000, 2007, 2022, and even the sharp correction of 1962. That’s why we watch it so closely.
Over the past six months, breadth has actually been improving – making new cycle highs – so there’s been no warning sign of a larger correction. Without deterioration, the clock never starts ticking. But once it does, it’s only a matter of time before the indexes follow.
For example, market breadth peaked in February 2021, but the S&P 500 didn’t top until 10 months later. The damage under the surface persisted quarter after quarter before ultimately dragging down the majors.
One of the simplest ways to track breadth is to count how many NYSE stocks are above their 200-day moving average. Put simply, that tells us how many stocks are in uptrends.
In healthy markets, this number climbs steadily – as it has for much of the past six months. But that number peaked on September 11.
For shorter-term breadth, we look at stocks above their 50-day moving average (roughly 10 weeks of trading). That reading actually topped way back in July and closed at new five-month lows yesterday.
The Culprits
Every major market decline has a group of stocks that leads the way lower.
During the Global Financial Crisis, it was the banks. After the dot-com peak in 2000, it was Tech. In 2021-22, it was the high-growth “ARKK” names.
As my friend Ari Wald likes to say, every correction needs a “culprit.” Without one, it’s tough for a broad market decline to gain traction.
One possible culprit this time could be Homebuilder stocks, which just closed at new multi-month lows.
Interestingly, this group tends to move closely in line with Industrials, so further weakness here could have broader implications
Maybe Homebuilders are the culprit this time. If we had to pick one, they’re the clear frontrunner.
Of course, they could always get bought up, invalidating any potentially bearish implications.
Same with breadth. Maybe it expands and we see new highs in stocks above their 200-day. Or maybe the divergences keep dragging on.
What matters is whether these warning signs start stacking up. Do more sectors join the list of potential culprits? That would signal deeper deterioration. If it’s just one group, odds are it works itself out.
This is exactly what I watch for in bull markets. Because, sooner or later, this is how stock prices fall. The only real question is when.
Stay sharp,
JC Parets, CMT
Founder, TrendLabs