Preparing for the Next Correction
Last week the Dow broke 17,000. Even the small-cap index, the Russell 2000, notched a new high, illustrating the breadth of this healthy bull market. The NASDAQ, believe it or not, is less than 15 percent away from the record set in the crazy dot-com era market of 2000. Yet valuations are not even close to the extremes of those days.
Even though new highs are bullish, the commentary in much of the news media we see and hear treats these records as a matter of great concern instead of a reason to celebrate the renewed vigor in our economy.
While we feel there will be additional gains over the coming years, we also know it is inevitable that every market has regular pullbacks and consolidations. Since the market made its lows in March 2009, it has had nine corrections ranging from 6 percent to almost 22 percent.
If corrections are a normal part of any market cycle, why do we fear them? We should simply accept them as an unavoidable aspect of long-term equity growth. Instead of approaching these events with trepidation, commit to preparing for the inevitable by charting a path with your advisory team that you can sustain through the good times and the pullbacks. The alternative is an emotional reaction to sell after the fact -- and that is never good for long-term portfolios.
Forecasting the timing of a stock market correction is difficult if not impossible. Even so, people constantly try to do so by picking the exact points at which to jump in and out of investments. Few, if any, are consistently successful, and that is before considering trading costs and taxes.
A trader, whose definition of “long term” is the week ahead, is concerned about an imminent drop of 5 percent to 15 percent. They try to avoid scares by trading within their portfolio, despite data showing that the average person loses 2 to 4 percent per year in so doing. Investors approach the same inevitability very differently. Anyone with a longer-term time horizon should view a correction as a normal course of events. If they happen to have excess cash flow, the market dip is a chance to put additional dollars to work. If certain sectors fare worse than others, SYM’s rebalancing discipline will trigger trades to sell higher and buy lower. In general, investors’ changes are more incremental than are traders’, and investors act on time-tested ways to make lemonade out of lemons.
Less is more when it comes to adjusting a well-thought-out plan.