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Crash, Correction or Pullback: What Follows a Seven Month Rally?

Crash, Correction or Pullback: What Follows a Seven Month Rally?

With the Sell in May mantra seems to be in shambles, and investors have proven for a seventh consecutive month that no dip is too shallow to purchase, the debate du jour has switched to "Now what?"

More specifically, what awaits us on the other side of the mountain following an uninterrupted 23% rally in stocks since mid-November?

"When we do get that eventual decline, and it will come, it will most likely be a pullback rather than a correction or a new bear market," says Sam Stovall, chief equity strategist at S&P Capital IQ, in the attached video.

For clarity's sake he characterizes a pullback as a 5% to 9.9% decline, a correction as a 10% to 19.9% retreat, and a bear market as anything worse than 20%.

"I think what investors forget is that we have had a pullback basically every year since World War II and we've had a correction once every less-than-three years, on average," Stovall says. "So to have a decline of five to twenty percent is really not a strange thing."

That said, as the chart below shows, the probability of a crash is actually lower, the larger the preceding run-up has been, which in the current case is about 23% and counting.

"I actually found that a greater the advance off of a prior pullback increases the chances that we end up with another pullback, rather than something deeper," Stovall says, adding "the implication is that investors are buying into an improving economy."

Of course, he always cautions that history is a guide and not a guarantee, but it is worth noting that he has a 12-month target of 1670 for the S&P 500 and recommends a 45% allocation to U.S. equities.