What is a market correction?
A stock market correction is when the market declines at least 10 percent right after an upward trend. A correction is like a runner in a foot race slowing down before pushing even harder. Every bull market has corrections – this is the natural course of market cycles.
Why do market corrections happen?
Market corrections are almost always caused by panicked selloffs, and so far this latest correction appears to be no different.
It is a frustrating fact of investing that novice investors can negatively affect the entire market when a large enough percentage of them works together to do the exact wrong thing at the exact same time. Panic ensues, the media picks up on the story and accelerates the momentum, the faulty message spreads, and markets tumble as people head for the exits. This is as common as it is inevitable.
So… how is a market crash different from a correction?
A stock market crash is quite different from a correction. First, that ten percent decline has to happen over a single day. And, with enough momentum from panicked investors, the losses can easily exceed ten percent. While corrections may have effects that last for weeks or months, crashes can lead to what is called a Bear Market. This is a larger correction in the markets of ten percent or more over a short period of days or weeks that leads to lasting losses from which recovery may take a year or more. If negative market activity continues over a prolonged period of time, then a downward spiral can begin, and the companies whose stocks have been so negatively impacted will have a difficult time going about their business.
That is NOT what is happening now . . . not even close. While it is always possible that investors could fall into a mass panic at the losses they have seen in this correction, it is far more likely that things will soon calm down, just as they have in countless other corrections. The numbers just don’t support any real likelihood of a crash right now. The best we can do is prepare.
What should we do now?
In reaction to the correction? If you are working with an advisor – nothing. Your Financial Advisor is reviewing your portfolio and rebalancing as appropriate. They know your risk tolerance and your growth needs and are reacting accordingly. Corrections can be excellent opportunities to take advantage of low prices.
If you are a do-it-yourself investor, then the same guidelines apply. Take this time to review your portfolio and rebalance, if necessary. Participating in the mania is never the answer.
How about protecting against a crash?
Same answer. You can’t predict a crash. It’s also next to impossible to accurately time an exit during a crash because it happens all at once. If you react during a crash, you are just participating in the stampede for the door and locking in losses unnecessarily. Take the market volatility this last week as an example. If you sold out on Monday, you missed the rally on Tuesday. If you sold Wednesday or Thursday, you missed the activity of Friday morning. It’s 10:30AM EST on Monday as I write this, and I can assure you I have no idea what the market will look like when it closes today. In the absence of a crystal ball foretelling me the next moves, the best any of us can do is to ensure that we are well-diversified and well-allocated in accordance with our tolerance for market risk and volatility.
This is exactly what FJY has been doing for our clients over many years. Responsible allocation, proactive and deliberate rebalancing, and a clear understanding of the relationship of risk and return are how we handle everything from the smallest corrections to the largest storms in our markets. Keep calm and stay the course.