Last March, the US Stock Market stopped it’s tailspin and reversed course, increasing 103% since it ‘bottomed out’ on March 21st. When we see the market essentially do nothing but go up, a funny phenomenon takes place; we get nervous! We know that withstanding market corrections are a normal part of being an equity investor, so we anticipate them when we see a sustained run of positive returns. We look for patterns, and when we see up, up, up, we prepare ourselves for down.
However, does the stock market move due to patterns? Does a good market-run die because of old age? Time and time again, we see that major market movements are caused by something more than that, and history shows that generally, the types of events that trigger market declines fall into two broad categories:
- Global Shock Events – These are the events we have no way of preparing for, predicting, or positioning our portfolios to withstand. Think terror attacks, global wars, large businesses going under and of course, global pandemics. Market participants do not like surprises, and these types of surprises do not treat market participants kindly. However, we have no way to combat these events ahead of time. Our best response is to be prepared when they do happen, both emotionally (ready to hold firm in the downturn) and strategically (rebalancing portfolios, investing excess cash, etc.).
- Changes in Future Economic Growth – The stock market today reflects what price market participants are willing to pay for the assumed future growth of the stock they hold. So, when future expectations become worse, prices go down, and just like that we have a market correction. The 2nd quarter was an indicator as to why the market continues to ride higher, as stock analysts’ earnings forecasts for Quarter 3 (their expectations about future earnings) continued to get better as companies reported their actual results. In fact, Q3 earnings estimates are almost doubled now compared to January. In short, expectations for future growth continue to be positive. Of course, we know these expectations can change quickly. And although history shows we cannot reliability predict when economic growth will slow, we can keep an eye on market fundamentals and strategically diversify our investments based on that data.
The market will correct again, we just don’t know what will cause it and when it will happen! However, we can focus on being strategically allocated and well-prepared for when the time comes. This allows us to not live in constant paranoia about a downturn, but to have confidence in our plan to handle it, whenever the time comes.
How have you prepared yourself to successfully ride through a market correction?
Sources: Yahoo Finance; Zacks Investment Research