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May 30, 2017

Should we fear a market correction?

Today’s stock market surely provides investors with a lot to think about. On one hand, the market is thriving, with several major indexes recently reaching all-time highs. On the other, we’re in the midst of the second-longest bull market ever, which has made many investors nervous about what could happen if there is a market correction (technically defined as an index declining at least 10 percent from a previous high).

To be sure, no one knows when or if a market correction will come, or what might cause it. It is also difficult for investors to estimate how much they could lose once a market correction happened. However, there have been several key economic indicators, particularly the weak stock performance in March, which have been making investors nervous about a potential market correction. In addition, falling commodity prices and recent political setbacks for the Trump administration may also be driving fears of a market correction.

Other investors are predicting that a steep market correction may occur given the length of the current bull market (now eight years) and the fact that we’ve experienced only four corrections during a time when the S&P 500 has more than tripled, according to a recent analysis by the Wall Street Journal.1 By comparison, since the late 1980s, the market typically has experienced an average of one correction per year, according to the Journal analysis. This has some investors worrying that the market may be due for a big correction this year.

Generally speaking, we believe it is best to stay in the market during a correction rather than sell positions.

Managing Your Market Correction Fears
While there are many factors contributing to investors’ worries about a potential market correction, it is important to put market downturns in perspective. For example, half of the market corrections since 1989 have not been part of a longer bear market, nor a symptom of a larger recession, according to analysis provided to the Journal from research firm Strategas Research Partners. According to Strategas, those corrections averaged about 2.4 months in duration and bottomed out after an average 14.2 percent decline. However, in the ensuing three months after those declines, the market gained 16.5 percent.

Generally speaking, we believe it is best to stay in the market during a correction rather than sell positions and/or accumulate cash, because most investors end up failing when they try to time the market. Selling during a
market correction can be an expensive mistake, as trying to avoid market declines can lead to your missing some of the most profitable days of the market.

As the chart below illustrates, even with the large market correction experienced in March 2009, a balanced portfolio of 40 percent stocks and 60 percent bonds would have fully recovered by November of that same year, whilea portfolio of 60 percent stocks and 40 percent bonds would have fully recovered by approximately a year and a half later.

Obviously, market corrections may be most hurtful to those portfolios with a shorter time horizon. By having a conversation with your advisor about your current asset allocation and risk tolerance, you may be able to address any anxiety you’re having about a potential market correction or crash.

Chart Source: J.P. Morgan Asset Management.

1Source: “A Correction Now Might Not Be So Bad, Some Investors Say,” the Wall Street Journal, March 27, 2017, https://www.wsj.com/articles/a-correction-now might-not-be-so-bad-some-investors-say-1490570768

This article was originally published in the May–June 2017 issue of Worth.

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