The Market Correction that we have warned about has materialized in an article entitled: Risks Of A Market Correction Significantly Increased. The S&P 500 index initially tried to rally this week, but then reversed and closed deeply in the red. Based on the extreme institutional positioning, even as the markets continued to head higher in late January and February, we were expecting a lower price until the rebalance has happened.
We started warning this when we drew the red line back January.
There’s at least $50 billion of selling pressure from institutional re-positioning and another $50 billion from hedge funds.
Currently in a “Market Correction”
Both the S&P 500 index (SPY) and the Nasdaq index (QQQ) are officially in a market correction. A market correction is defined as a 10% to 20% pullback from the most recent highs. The sell-off can be attributed to a combination of profit taking and protective sell orders. Given the magnitude of the pullback, automated computer algorithms probably had a lot to do with it.
Market corrections are usually violent and scary. Many retail investors panic as they see big losses on their holdings. During such periods, volatility also picks up with sharp downswings and upswings. Currently, the markets are oversold and we could see a bounce.
Should We Sell Everything Now?
No! It’s unlikely that we will see a bear market. We are only in a market correction. Market corrections last on average three to four months and tend to fully recover after another three to four months. So the entire cycle, from day the market corrects until full recovery is six to eight months. The recovery tends to be very swift and sharp, so trying to trade in order to buy lower is not recommended. This time around, the market correction is likely to recover sooner than usual.
Why We Remain Optimistic
The stock market is still in the midst of its longest bull run on record, which began in March 2009 out of the ashes of the great financial crisis. The U.S. economy is still on solid footing. The Commerce Department reported that US single-family homes raced to a 12-year high in January. New home sales jumped 7.9% to an annual rate of 764,000 units last month, the highest level since July 2007. The gain in home sales was driven by rising mortgage application volume which rose 1.5% last week from the previous week, according to the Mortgage Bankers Association. Alongside this we also have hit the lowest unemployment rate since 1969.
International investors look at US stocks for safely. The U.S. economy is still considered to be the most resilient, so it makes sense to see smart money flow here.
In fact such massive selloffs are healthy and allow the markets to consolidate. The first step is to accept that corrections are a normal part of any bull market and necessary for the sentiment to re-balance.
Difference Between A “Market Correction” and a “Bear Market”
- Market correction: Is defined as a drop of at least 10% or more for an index or stock from its most recent high.
- Bear market: Is defined as a 20% or more decline in stock prices.
Statistics about market corrections and bear markets
Source: High Dividend Opportunities
What You Need To Know About Market Corrections
- Stock market corrections happen often (about once a year).
- They tend to happen for no specific reasons.
- Market corrections rarely last long (about three to four months on average). They also take another three to four months to recover. So after a period of six to eight months from the start of the correction period, stocks fully recover.
- They should only matter for short-term traders and not long-term investors.
- In most market corrections, there’s a sharp V shaped recovery, with very little bottom building or retracing.
- A stock market correction is often a great time to pick up high-quality companies at an attractive valuation.
What to Do In a Market Correction
- Don’t make hasty decisions. Be patient, and take the long view.
- Market recovery will come sooner than you expect.
- Do not try to time a bottom. Market recoveries tend to be sharp and steep. If you try to time it, you will most likely miss it.
- Make sure you are not on heavy margins. This will magnify losses and can trigger a margin call resulting in unnecessary losses.
- Stay well diversified across all sectors. Don’t increase exposure to any particular sector.
- Despite all the corrections and bear markets, equities have fared the best in the long run. The S&P returned a “compounded annual growth return” (CAGR Annualized return) of 9% both over the past 10 years and the past 20 years. It pays well to be a long-term investor.
- Go bargain hunting for the best stocks, especially dividend-paying ones. If your portfolio is generating high income, it’s a good time to use it for take advantage and average down.
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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.