Is a Market Correction Such a Bad Thing?

 

Yes, it’s official: the first market correction in more than four years is upon us.

Right on the cusp of a 10% pullback headed into yesterday, for the first five-and-a-half hours of trading it looked the market was going to pull yet another Houdini escape and avoid a true correction yet again. Then came the last hour, when the Dow Jones Industrial plummeted 516 points in 60 minutes. Yikes.

So now the S&P 500—typically the barometer for market corrections—has declined 11.2% in the last six trading sessions, 12.3% since its late-July zenith. That’s a true market correction by any measure.

But is that such a bad thing? For months, years even, Wall Street pundits and value investors alike have insisted that the stock market is severely overbought, and that we’ve been due for a correction for quite some time. They may have a point. Market corrections can be a healthy way of hitting the reset button, giving investors a chance to get back in at much better prices.

Now, there’s a big difference between a correction and a collapse. Corrections are healthy; collapses are not. There was nothing healthy about the 2007-09 recession-induced collapse, with the S&P falling more than 52% over an 18-month span. That’s called a bear market.

Barring an unlikely double-dip recession, we’re not likely to see that kind of dropoff again anytime soon. But any decline of more than 20% qualifies as a collapse. If stocks fall that far, it’s not good for anyone.

Corrections, on the other hand, are a natural occurrence, a toll investors must occasionally pay on the road to long-term gains. No market has ever risen in a straight line forever. Eventually, the market needs to catch its breath. In the long run, it can be rejuvenating.

Consider what happened after the last couple corrections of more than 10% (but less than 20%).

  • From April to June 2010, the S&P fell more than 13%. It shot up 32% over the next 10 months.
  • In July and August of 2011—the dates of the last true market correction—the index declined more than 16%. It rose 25% in the next six months. 

At the time, those sharp declines had investors as worried as they are now—probably more so, since they occurred shortly after the crash when rumblings of a double-dip recession had Wall Street still on edge. In the long run, those pullbacks were little more than speed bumps briefly slowing stocks down on their way to nearly tripling in the last six years.

This latest market correction could be just another speed bump—and frankly a much-needed one, given the unrelenting nature of this bull market over the last three years. We could all use a few bargain buys right about now.

My Cabot Investing Advice colleagues, especially the growth experts, are advising that you sell at least a portion of your portfolio until the dust settles, and that certainly makes sense. This is a good opportunity to clean out some of the clutter in your portfolio and focus only on the stocks you like best, the ones you’re convinced will make you lots of money in the long term. Plus, by going to cash and avoiding any major losses, you can sit on the sidelines and watch the carnage unfold without having to worry that your retirement might be put on hold for a couple more years.

Eventually, stocks will turn around. It could be tomorrow. It could be a year from now. When they do, the returns will be significant—the way they were after the last two market corrections. 

Stock Market Downtrend

I don’t have to tell you that there’s a major market upheaval afoot.

However, if you follow the simple path I lay out, you will see your wealth continue to rise as your fellow investors continue to rue the bust. Click here to find out more.


Stock Picks

Tesla Motors

If Tesla ever begins to cut back on development and innovation costs, earnings will soar.

Alibaba

China seems to be raising up its very own version of Amazon in Alibaba (BABA.

Facebook

Roy Ward uses the PEG ratio to determine if the stock is undervalued or overvalued.

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