by Denise Chisholmm Director of Quantitative Market Strategy, Fidelity Investments
Market corrections are “normal” and “healthy” - until they happen. Historically, 5% pullbacks occur about three times a year, and 10% corrections at least once annually. In fact, most years see a 5–15% drawdown at some point yet finish higher roughly three-quarters of the time. That math underpins the “buy the dip” mantra. The challenge, of course, is gauging whether a decline will be deeper or longer. Certainty doesn’t exist in markets, but history offers clues – most of which tend to be contrarian in nature.
Fear, however you measure it, often serves as the ironic buy signal. One of the most reliable gauges I watch is the gap between fear in equity markets (VIX) and fear in credit markets (high yield spreads), because that’s where history shows the most consistent patterns. Credit markets are often the “smarter market,” historically sniffing out trouble first. When credit markets signal increasing stress, but equity markets show little concern, that’s been a poor setup historically - one we saw ahead of the financial crisis and the tech bubble.
But when stock market fear outpaces the concerns in credit – the situation we’re currently in - forward returns tend to be strong. In fact, that dynamic has consistently defined this cycle: persistent equity anxiety. Bad news will happen, but when fear in equities runs higher, history suggests much of the bad news may be priced in.
Sentiment adds another contrarian layer. The AAII survey, a weekly measure, has quickly retraced it’s rise after April’s tariff tantrum and is now back into the bottom decile of its history since the late 80s.
These extremes have mattered: not as a timing tool for the bottom, but as a signal that six- and twelve-month forward returns tend to skew strongly positive. The more bearish sentiment gets, the better the historical odds for future gains. Why? Markets are much more likely to peak on optimism than pessimism. None of this guarantees smooth sailing – and there are always exceptions - but history suggests that when fear and sentiment hit these levels, the odds tilt toward opportunity. So, while headlines will keep feeding the wall of worry, the data argues that climbing it remains the more probable path.
This information is provided for educational purposes only and is not a recommendation or an offer or solicitation to buy or sell any security or for any investment advisory service. The views expressed are as of the date indicated, based on the information available at that time, and may change based on market or other conditions. Opinions discussed are those of the individual contributor, are subject to change, and do not necessarily represent the views of Fidelity. Fidelity does not assume any duty to update any of the information.
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