A correction is a beautiful thing, simply the flip side of a rally, big or small. Technically, corrections adjust equity prices to their actual value or “support levels”. It’s much easier than that. Prices go down because of speculator reactions to expectations of news, speculator reactions to actual news, and investor profit taking. The two former “becauses” are more potent than ever before because there is more self-directed money out there than ever before. And therein lies the core of correctional beauty! Mutual Fund unit holders rarely take profits but often take losses. Additionally, the new breed of Index Fund Speculators is ready for a reality smack up alongside the head. Thus, if this brief little hiccup becomes considerably more serious, new investment opportunities will be abundant!
Here’s a list of seven things to think about doing, or to avoid doing, during corrections of any magnitude:
1. Your present Asset Allocation should be tuned in to your long-term goals and objectives. Resist the urge to decrease your Equity allocation because you expect a further fall in stock prices. (depending on age of retirement) That would be an attempt to time the market, which is (rather obviously) impossible. Asset Allocation decisions should have nothing to do with stock market expectations.
2. Look at the past. There has never been a correction that has not proven to be a buying opportunity, so start collecting a diverse group of high quality, dividend paying, NYSE companies as they move lower in price.
3. Don’t hoard that “smart cash” you accumulated during the last rally, and don’t look back and get yourself agitated because you might buy some equities too soon. There are no crystal balls, and no place for hindsight in an investment strategy. Buying too soon, in the right portfolio percentage, is nearly as important to long-term investment success as selling to soon is during rallies.
4. Look at the future. Nope, you can’t tell when the rally will come or how long it will last. If you are buying quality equities now, you will be able to love the rally even more than you did the last time… as you take yet another round of profits. Smiles broaden with each new realized gain, especially when most people are still just scratching’ their heads.
5. As (or if) the correction continues, remember you can make money as prices fall by shorting or buying bearish or inverse securities. The saying goes; “The trend is your friend”. The weaker the company most likely will trend lower. Hope for a short and steep decline but prepare for a long one. You can make some amazing profits as the market declines well before the new rally begins.
6. Identify new buying opportunities using a consistent set of rules, rally or correction. That way you will always know which of the two you are dealing with in spite of what the Wall Street propaganda mill spits out. Focus on value stocks; it’s just easier, as well as being less risky, and better for your peace of mind. Just think where you would be today had you heeded this advice years ago…
7. Examine your portfolio’s performance: with your asset allocation and investment objectives clearly in focus; in terms of market and interest rate cycles as opposed to calendar Quarters (never do that) and Years; and only with the use of the Working Capital Model, because it allows for your personal asset allocation. Remember, there is no single index number to use for comparison purposes with a properly designed value portfolio.
Corrections (of all types) will vary in depth and duration, and both characteristics are clearly visible to those educated in the financial markets. The short and deep ones are easier; the long and slow ones are more difficult to deal with. Unlike many things in life, Stock Market realities need to be dealt with quickly, decisively, and with zero hindsight. Because amid all the uncertainty, there is one indisputable fact that reads equally well in either market direction: there has never been a correction/rally that has not succumbed to the next rally/correction…
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