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The historical reason why stocks could fall further

History says it will get worse for stocks: Carter Worth
History says it will get worse for stocks: Carter Worth

Is Wall Street's biggest question: After a 7 percent drop from the highs, has the bottomed out? The answer may be impossible to know for sure, but historical analysis suggests that stocks may have a bit further to fall.

Carter Worth of Sterne Agee looked back on all the market's corrections of 5 percent or more going back to 1927, in order to get a sense of how long they tend to last, in terms of both time and magnitude. He learned that the average (mean) correction is 12.2 percent, and lasts for 41 sessions. The median correction, which is shallower because it is less affected by outliers, is 8.2 percentage points deep and lasts 22 sessions.

Given that the S&P closed Tuesday just over 7 percent off its highs, Worth takes this information as an indication that there will be more to this selloff.

"Were it to just be in line with the median, it means we have at least a percentage and a half to go. Were it to be in line with the mean or average decline, we're talking about another 4 or 5 percent to go. The principle being that this is unlikely to be at an end," Worth said Tuesday on "Futures Now."

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Additionally, stocks were at all-time highs a mere 18 sessions ago, "so it's not even mature in terms of duration, not to mention magnitude," Worth added.

And while this may be dismissed as a quirk of statistics—after all, if one starts with all the time that stocks ever fell more than 5 percent, one is bound to find a bevy of times when it has fallen substantially—Worth says there are specific market dynamics that get triggered when stocks drop 5 percent or greater.

"The reason that that's an important number is that when a stock or an index or a currency goes down 2, 3 percent, nothing really happens, that's noise," Worth said. But starting at 5 percent, "stop losses start kicking in, or people start to de-risk, or margin calls [are triggered], or the spouse calls up and says, 'My gosh, we're losing money, do something.' The point is that once you're down 5 percent, you usually go down more."

It's certainly looking that way on Tuesday morning. S&P futures are down sharply in early trading, with the December S&P futures contract hitting the lowest level since April.

5%+ Corrections Mean Median
Duration41 Sessions22 Sessions

This logic makes sense to Brian Stutland of Equity Armor Investments, who points out that with some stocks down sharply for specific reasons, such as the sharp decline in oil prices, there are bound to be some broader ramifications.

"I think there's been a repricing of risk," Stutland said. "You can't have Exxon Mobil go down 10 percent with no repercussions to the system. Equities might be the best place on the block, but you can't have no volatility in stocks and a lot in other asset classes."

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Trader on the floor of the New York Stock Exchange.
Getty Images

Of course, people who believe in the longer-term strength of the market are unlikely to be convinced by Worth's data, which arguably shows that further downside is likely to be limited.

"We're within the margin of error of the median drop," pointed out Scott Nations of NationsShares. "If the median break is 8.2 percent, then exactly half are above that and half are below that. So I don't think much of this, especially if we're in spitting distance of the median."

Indeed, after a 5 percent pullback, stocks tend to be 5.28 percent higher in six months' time, according to Morningstar data. And four months after a 7 percent pullback, the S&P has recouped all of its losses 80 percent of the time.

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