Mindset & Market Corrections

November 13, 2018
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By Matt Rinkey

If you watch the financial news (which we don’t recommend) you will hear many reasons for why the market has declined approximately 10% from its peak in early October. Culprits have been assigned to rising interest rates, inflation fears, China’s slowdown, trade wars, and high valuations, amongst others. If you really think about it, many of these factors have been in place for months, if not years.

We have communicated at length over the past several years how we are very late in the economic and market cycle and that more volatility should be expected in the years ahead. That said, just because we know we are late in the cycle it is impossible to know for sure when any market decline will actually start and how deep the decline will be (it’s been the 8th inning for a few years now).

The action of the past month reminds us that stock market declines have not gone away. In the United States, this magnitude of this decline is what market observers would call a “correction”. A correction is when the stock market declines from 10-20% off its peak. A decline over 20% is considered a bear market. Historically, the average correction has lasted only 54 days—less than two months! In other words, most corrections are over almost before you know it. That may make things less frightening, right?

But if you are really astute, you will recognize that every market decline (of “correction” and “bear market” quality) has always resolved itself to the new highs…and the market spends a lot of time at new highs.

Stock market declines are of course frustrating for all investors, as gains achieved over many months can evaporate in a matter of days or weeks. However, periodic, sudden downdrafts are a part of investing and investors should learn to expect them and resolve to pro-actively employ tactics to take advantage of them and to use them to ultimately strengthen their overall financial foundations (which is what we do).

Investors have behavioral biases and one that is very prevalent is called Recency Bias. This bias causes us to see the market from the lens of the recent past and make incorrect decisions about how the stock market actually behaves. 2017 was a year of extremely low market volatility and with the Great Recession 10 years behind us, many investors have become accustomed to shallow market declines. So even typical corrections feel like the world is ending. If we separate our biases from facts and market history, we can see from the table below that 10% declines happen quite frequently, pretty much every year. Since 1945, the S&P 500 has experienced a double-digit correction roughly once every other year and a bear market once every 5 or 6 years. These things are a feature, not a bug of a well-functioning stock market. If we never got corrections, stocks wouldn’t earn the risk premium they do over safer alternatives.

The concern we have is that after a long period of market calm, a sharp decline will compel investors to “react” and abandon their financial life and investment planning. We promise, that is not the answer. Here’s what you have to remember: based on more than a century of market history and even when the short-term outlook may look dire, the stock market always rebounds. This historical perspective should give you unwavering peace of mind, and I hope it will help you to keep your eyes on your financial life goals, regardless of the financial media or the corrections and crashes we will face in the years and decades to come. The best investors know that the gloom never lasts.

In the stock market, ALL declines have been temporary. History doesn’t tell us what is going to happen next, but that doesn’t mean we can’t invest both successfully and profitably over the long-term. As for us, we will always focus on your goals and objectives to ensure you achieve the greatest return on your entire financial life.