Market Flirts With a Correction: What Should You Do?

The market has been turned on its head since the start of September, as investor confidence has been dented by rising levels of new coronavirus infections in the U.S. and Europe, along with signs that the global economy’s recovery will be slow and uneven. Add to that the uncertainty and political risk associated with November’s elections, and the market’s nerves are showing signs of fraying. Investors are also looking for signs of progress on additional stimulus spending by the U.S. government, with reports of House Democrats readying a scaled-down package of “only” $2.4 trillion. However, House Republicans are voicing doubt that a deal can be reached before Election Day.

After hitting new all-time high intraday and closing levels on September 2, the S&P 500 and the Nasdaq composite have both pulled back sharply. The S&P 500 was down 10.6%, comparing its intraday high of 3,588.11 on September 2 to its intraday low of 3,209.45 on September 24, while the Nasdaq is down 12.9% intraday high to intraday low. If you only consider closing prices, the S&P 500 is down 9.2% from its close on September 2, while the Nasdaq is off by 11.1%.

A decline of 10% or more from a recent peak is the classic definition of a market correction. While the question of whether the S&P 500 is in correction is up for debate, the issue is clear cut for the Nasdaq—the index, and technology stocks, are in correction.

Historically speaking, the nice thing about corrections is that more often than not, price drops of this magnitude often “correct” and return to their longer-term trend. As investors undoubtedly know, past performance is no guarantee of future results, but history is oftentimes what we base our decisions (and sometimes hopes) on.

Whether or not a correction “corrects” itself or turns into a full-blown bear market (a 20% decline from a recent peak) is anyone’s guess. According to the Schwab Center of Financial Research, most corrections don’t become bear markets. There have been 24 market corrections since November 1974, according to Schwab, and only five of them have become bear markets (which began in 1980, 1987, 2000, 2007 and 2020).

If this current downturn grows into a bear, history also shows that since 1966 the average bear market lasted roughly 15 months, according to Schwab. This is far shorter than the average bull market. Furthermore, bear markets often end as abruptly as they begin, with a rapid rebound that is difficult to predict. Take, for example, the last bear market, which took place earlier this year as the coronavirus pandemic battered global stocks. That bear market was the shortest on record—lasting a mere 33 days from the S&P 500’s peak on February 19 to its trough on March 23. This is a primary reason why we strongly suggest that long-term investors plan ahead to allow you to stay the course and not jump out of the market.

What should you do now?

It’s easy to invest when the market is strong, as was the case between April and the end of August. It’s during that time when it’s best to make plans for when things start going sideways or when the market falls. Here are some steps to consider when the market starts weakening:

• Have a financial plan. A written financial plan can help you craft and maintain an appropriately balanced portfolio. It also instills discipline into your investment plan and helps you to navigate better when the market tempest arrives.
• Review your risk tolerance. It’s easy (relatively speaking) to take risks when the market is in an uptrend. When the market takes a turn, it may be time to make some tactical asset allocation decisions. Part of this is tied to how much of a loss you can accept and still sleep at night.
• Consider when you need money from your investments. Too many times I have heard about investors who were fully invested right up until the time they were planning to retire or fund a major endeavor, such as sending their child to college. Generally speaking, if you are going to need money from your portfolio in the next three to five years, it should not be invested in stocks. The money to last you a few years should be in highly liquid and safe investments, such as cash or a money market account. Having that “cash bucket” ensures you have the money for short-term needs without having to sell during a down market.
• Develop a shopping list. If this current correction turns into a bear market, it will turn into a bull market at some point. Knowing what you want to buy ahead of time once the market changes direction will help you to act quickly and decisively. Keep in mind, though, that the stocks that were the strongest over the last several months won’t necessarily be the same ones that lead a rebound. Be sure to cast a wide net.

From SSR Weekly Update, 9/26/2020.

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