The stock market has enjoyed a pretty steady climb upwards since the November election. Could that calm soon be coming to an end? If so, it’s a good time to brush up on market corrections and how you can take volatile and hostile markets in stride.
1). Just what is a correction? A correction is an investment term for a market pullback when stocks are down 10% from their highs. For example, a 10% correction from today’s prices would signal a drop from 20,400 on the Dow Jones Industrial Average to 18,360.
2). Will there be a correction soon? Based on nothing other than recent history, it’s fair to say there may be a 5% or 10% pullback soon. Since 1990, we have averaged a 5% decline (or “correction”) about 3 times per year on average. Declines of 10% or more happen about once per year on average. A 20% correction is less frequent (fortunately!), occurring every 3 1/2 years on average. So it’s fair to say that a correction is not a question of “if.” It’s a question of “when.”
Test Your Market IQ: Bet you can’t even remember these fairly recent market plunges or what “caused” them. According to veteran market researcher Dr. Ed Yardeni, the last correction in early 2016 brought prices down 13.3% and lasted 200 calendar days. The last correction before that, in August 2015, shocked investors with a 1,000+ point drop on the Dow. That downturn lasted 96 days and prompted a 12.4% drop. Who can even remember the “cause” of both drops? (Hint: if you guess China and oil, you’re probably right).
3). But can’t we predict when it will happen? Researchers have studied market behavior over the last century. Their conclusion? “It’s easy to look back today and say with hindsight that the stock market was overvalued at a particular time and due for a decline. But no one has been able to accurately predict market declines on a consistent basis. Successful market timing during a decline is extremely difficult because it requires a pair of near-perfect actions: getting out and then getting back in at the right time.” We think there are better ways to control market risk – such as proper asset allocation, diversification, dollar cost averaging, and liability management – that don’t compromise your ability to capture the market’s long-term growth.
4). What should I do if and when prices correct? In most cases, the right thing to do is “nothing.” If you are fully invested, stay that way. The worst thing you can do is sell when prices are lower, only to buy back when they go back up again. And don’t forget, pullbacks can often be valuable buying opportunities. Corrections often don’t “mean” anything. They just happen.
Test Your Market IQ: Check out Ed Yardeni’s charts showing market corrections and bear markets since 1929. Here’s the takeaway. It goes up and down all the time, so stop stressing. Over time, and over the long-haul, it goes UP. If you pick investments and an asset allocation that’s well-suited to your time horizon, goals and circumstances, you’ll do fine. If you don’t know what you’re doing, get professional help.
5). Can’t I invest without experiencing these downturns? “Stock market corrections are an inevitable part of investing,” say researchers. By accepting the normal up-and-down risks of the stock market, you get a ticket to participate in long-term gains that only the stock market has been able to generate.