Anatomy of a Correction

2018.02.29

February is over, but the stock market correction (arbitrarily defined as a decline of more than 10% from a previous high) that began at the end of January is still with us. Until this week, it looked as if the market would recover rather quickly with minimal backsliding. However, back-to-back declines on February 27 and 28—totaling –2.7% on the ACWI equity index of global stocks suggest that this will not be the case.

But do not let this week’s declines concern you, as they are perfectly normal during market corrections, while a rapid recovery to prior highs without any intervening drops would be most unusual. Nearly every stock market correction in history features a double bottom, with the second one occurring 3 to 8 weeks after the first and at around the same price level. If the current correction follows this playbook, a secondary bottom should occur within the next 1 to 4 weeks (i.e., before the end of March). We would not be surprised to see the major indexes drop another –5% from here before finally rebounding. This may not happen, but you should be prepared in case it does.

The process of finding a bottom is always a bit ugly: big market moves in both directions, hard-won gains wiped out in a flash, individual stocks sometimes moving 10% in a day, and of course, fear all around. Typically, investor anxiety crests around the time of the second bottom rather than the first, meaning that fear may not yet have peaked. Investors, being human, often want to get out and seek shelter until the storm passes, most often near the lows. This would be a mistake.

Identifying a stock market bottom is essentially impossible: mere mortals can do so only by sheer luck. And getting out of stocks during times like these can be riskier than staying in because prices move so quickly. Even if you are correct and stock prices go lower after you sell, you may not be able to buy back in before prices rise above where you sold. Believe me, we tried this more than once many years ago and concluded that it was that it was a losing battle.

How do we know for sure that this correction won’t morph into a true bear market, with a decline of more than 20%? We don’t, but the evidence argues against this, as we discussed at length in our recent quarterly newsletter. And the Fed wouldn’t be raising rates if the economy didn’t appear to be on solid footing.

Of course, the Fed could be wrong and so could we. But the same caution applies to finding a bottom in a bear market as in a correction: it’s basically impossible. Instead of attempting to time the market, invest for the long term and try to ignore short-term gyrations, as they are just noise in the bigger picture. You’ll probably sleep better as well.

Dr. Ken Waltzer, MD, MPH, AIF®, CFA, CFP®
Managing Director, KCS Wealth Advisory

Laura Gilman, CFP®, PFP, MBA
Managing Director, KCS Wealth Advisory

Nick Nejad, CFA
Director of Investment Research, KCS Wealth Advisory

 

 

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