Why There Has To Be Occasional Market Corrections

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Why Invest … At all!

DJIA plummets 470 today!

By Lon Jefferies CFP MBA lon@networthadvice.com | http://www.networthadvice.com 

Lon JefferiesWhy do we invest in the stock market? To make money so we can improve our standard of living, right?

Notice that we aren’t investing just to get our money back. If we simply wanted our money back, we would place the money in a savings account at a bank where we would likely be able to access it any time and know that we could redeem it at full value.

However, making money is better than simply getting our invested dollars back, so there has to be a trade off for receiving that additional benefit.

Market Corrections

Of course, the trade off is that investing in the market involves more risk than simply depositing money in a bank account. The additional return that is required by investors for investing in an asset that could potentially lose money is called the equity risk premium. There must be a potential downside in exchange for the larger reward that can be obtained by investing in the stock market. Otherwise, no one would ever deposit money into the more secure bank accounts and people would always invest in the stock market generating superior returns. Unfortunately, this would make things too easy, and as we have learned our whole lives, the easier a goal is the less reward we get for achieving that goal. That is why positions that can only be filled by a select few individuals with rare talents (CEOs, doctors, Lebron James) are handsomely compensated.

By now, most people know that over a sufficiently lengthy period of time, the stock market has historically produced returns of approximately 10% per year. This seems like a simple and easy way to make money, so why don’t all investors buy stocks and hold them for extended periods of time? The fact that we aren’t all rich suggests that buying stocks and allowing the market time to do its thing isn’t easy. This is because enduring risk and suffering losses creates negative emotions that get the best of many investors, causing them to sell at the wrong time and stop investing new dollars.

Yet, when we refer back to the concept that the tougher the task the greater the reward, we should be happy that buying and holding stocks isn’t easy because it makes the strategy more profitable.

For this reason, the next time the market goes through a correction or even a crash, wise investors should be grateful. Market volatility causes unsuccessful investors to sell when prices are down and increases the rewards for those who can stick with their investment strategy by holding their assets or even buying new positions.

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coffee

[Publisher Dr. DE Marcinko’s Grateful Bear Market ReSet and ReLaxation Time]

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Supply and Demand

Supply and demand suggests that when the markets are decreasing in value, more people are selling assets than buying. The people who are selling their investments at a loss create an equity risk premium for those who can endure market volatility. This increases the reward for successful investors by both providing an opportunity to buy assets when they are inexpensive, and reminding the marketplace that investing in volatile positions is unpleasant. Of course, things that are unpleasant aren’t easy to accomplish, which means there is a large benefit for achieving those things.

Thus, market corrections are great for successful investors because it is volatility and easily-rattled buy-and-sell investors that enable buy-and-hold investors to make significant profits over the long term. In fact, it wouldn’t be possible for stock market investors to make money without periodic intervals of unpleasantness as it is this discomfort which causes some investors to sell and creates an equity risk premium for the rest of us.

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Japan and world markets tumbling - dollar stronger

[Japanese Markets]

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Great Fall of China

Until the Great Fall of China recently, it has been easy for investors to buy and hold for the last six years as the market has been nothing but accommodating since early 2009.

However, when things get too easy, it reduces our reward for being a long-term investor because everyone can do it. For this reason, we need the market to experience a correction at some point to shake out the unsuccessful investors, causing them to sell assets and create an equity risk premium once more.

Assessment

When the next correction occurs, you can either sell assets and create a risk premium for others, or you can stay invested and take advantage of the money unsuccessful investors leave on the table. Successful investors with a sufficiently lengthy investment time horizon remind themselves of this concept frequently so that when the market experiences a decline they aren’t overcome by fear but grateful for the opportunity provided by the short-sighted. 

Conclusion

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6 Responses

  1. The Odds of Stock Market Correction

    As of today, all three market indices Dow Jones, NASDAQ and the S&P 500 are in correction territory, meaning they’ve all fallen more than 10%. Last time this happened was in 2011. Then I wrote an article “How Often Does Market Correction Happen?” to calm the nerve of my clients and readers.

    http://investment-fiduciary.com/2011/08/05/how-often-do-market-corrections-happen/?utm_source=The+Odds+and+Depths+of+Stock+Market+Corrections&utm_campaign=ConstantContact&utm_medium=email

    The key insight from that article is this. A 10% correction happened every other year in history, so you shouldn’t be surprised by it, nor should you panic. In particular, this 10% correction is kinda over-due since that last one was 4 years ago.

    In addition, don’t be surprised by a 20% correction over the next month and a half. The last time we had a 20% correction was in 2009. That was 6 years ago. In history, a 20% correction happened every other five years; give or take.

    The bottom line is that, corrections are parts and parcels of the stock market. They should be expected.

    Just like periodic sales announced by major department stores, the stock market has its’ own periodic sales as well, though the timing, during and depth of the sales are not announced in advance. Nevertheless, whatever you do when department store sales are going on, you should do the same when stock market “sales” are going on, as well.

    Michael Zhuang
    [Founder MZ Capital]

    Like

  2. The Markets

    U.S. stock markets finished last week higher than they started it, but the five-day ride was awfully bumpy.

    Concerns about China’s slowing growth, shifting currency valuations, and falling stock markets, coupled with uncertainty about the Federal Reserve’s next monetary policy move, contributed to malaise in world markets early last week.

    After falling by about 6 percent the previous week, U.S. stocks spiraled even lower early last week. They flirted with correction status (a correction is a 10 percent drop from previous highs) before moving higher.

    By midweek, markets were on the rebound, bolstered in part by the comments of New York Fed President William Dudley who indicated a September rate hike might not be all that compelling. Strong U.S. economic data also soothed some investors. Barron’s reported:

    “The economic data, however, have been good enough to suggest that the market is too pessimistic. There was that strong second-quarter gross-domestic-product reading, which even included signs of stronger capital spending, while good housing data suggest that third-quarter GDP could be better than many observers expect.”

    Market whiplash left investors feeling pretty shaky, as did late-week comments from Fed Vice Chairman Stanley Fischer who indicated it was too soon to know what the Fed would decide about interest rates in its September meeting. He indicated the decision would depend on economic data that is still being collected.

    While the market’s end of week bounce was welcome, The Wall Street Journal reported traders and investors appear to be ready for additional volatility.

    Whether markets are volatile or calm this week, it’s important to remember that it’s impossible for any of us to control what happens in Washington, on Wall Street, or on Main Street. We can, however, control how we prepare for and respond to market volatility. As you know, we believe thoughtful goal identification, risk tolerance education, and a disciplined approach can help investors reach their long-term financial goals.

    We understand that market volatility is uncomfortable, but it is not unusual or unexpected. If you have any questions or would like to discuss recent events, please contact your financial advisor.

    Arthur Chalekian GEPC
    [Financial Consultant]
    Encino, CA

    Like

  3. Volatility

    I read a quip in the local paper over the weekend: The stock market takes the stairs up but the elevator down. As I felt the elevator begin its descent this week, my stomach lurched a bit, but I kept coming back to the fact that good investing requires discipline and a bit of courage. You need discipline to stick with a well-established long-term investment plan and courage to endure short-term volatility.

    The correction in the stock markets worldwide over the past week is understandably disconcerting. Investors are wondering what happened and what’s next for global markets.

    First, some perspective

    • Market corrections are not unusual. On average, equity markets experience a correction, defined as a drop of 10 percent or more, every 18 months. It’s been nearly four years since the market entered correction territory in October 2011. Even with this context, it’s difficult to stomach sharp drops in the market. I urge investors to look more broadly and consider the recent dip against a backdrop of a long period of steady market gains. Over the past month, the S&P 500 Index dropped about 10 percent, albeit gaining back some ground recently. By contrast, the index has risen more than 200% since March of 2009. This week’s events, although unpredictable, are part of the broader cycle of market ups and downs.

    • Multiple factors contributed to recent volatility. Many headlines point to China as the cause of this week’s equity sell-off around the world. Yes, fear of weaker growth in China and the recent devaluation of the yuan certainly contributed to the volatility in the global markets, but those aren’t the only reasons. Global growth expectations beyond China remain tempered, commodity prices are falling, and no one knows for sure when the Federal Reserve will raise interest rates. These economic challenges have been around for some time, and we expect they’ll continue to create periods of volatility in the future.

    • The U.S. economy remains resilient. Despite global headwinds, economic indicators such as employment, housing statistics, and consumer confidence continue to show healthy gains. Escalating volatility may impact the timing of a decision by the Federal Reserve to raise interest rates, but we believe a 2015 rise is still likely.

    Second, some patience

    This is the challenging part of investing. It’s tough to sit tight and stay calm when we live in a world of 24-hour news cycles amplified through social media and smartphone alerts. “Tuning out the noise” is difficult when the noise is seemingly everywhere.

    No one can predict what’s next for global markets. That’s why today’s chatter about what the market is doing or might do is meaningless, and potentially dangerous, for the long-term investor.

    Instead, focus on what you can control: your goals, asset allocation, costs, and discipline to stick to your plan. These are the four principles that drive investment success. They are easy to recite, but can be harder to sustain, especially in times of uncertainty. Investors who can adhere to these four principles, while keeping some perspective and patience, will be well positioned to weather any market.

    Grainger

    Like

  4. More on the Markets

    The market is as streaky as a slice of bacon.

    U.S. stock markets have been sliding higher. They’ve been sliding lower.

    Barron’s reported the Standard & Poor’s 500 Index has tumbled from gains to losses and back again for 10 weeks in a row. The Dow Jones Industrial Index has tagged along with nine weeks of flip-flops. You’d almost think they were running for office.

    There are market optimists. There are market pessimists.

    The American Association of Individual Investors (AAII) weekly survey of investor sentiment reported 34.6 percent of respondents were bullish. That’s up from the previous week. Thirty-five percent of respondents were bearish. That’s also up from last week. What’s down? Neutral sentiment. More people are forming opinions about the possible direction of the market.

    There are questions that need to be answered.

    Will the Federal Reserve begin to raise rates this week? Some say yes. Some say no. Barron’s said it’s too close to call. There is no clear consensus, Fed officials have given mixed signals, and the bond market has not priced in a rate hike. If the Fed does raise rates, experts cited by Barron’s said markets could get ugly for a little while or they could remain calm. A lot depends on the wording of the Fed’s statement.

    Have Chinese markets stabilized? MarketWatch reported the Shanghai Composite Index finished last week higher. It was the first positive weekly outcome in a month. Chinese authorities, once again, are taking steps to stabilize markets. The Economist offered this thought, “As China’s financial markets develop, its stock market will become less bumpy. For now, investors must remember that many things are bigger in China, including the daily ups and down of its stock market.”

    Will the U.S. government shut down again? It’s in the hands of our elected officials.

    Arthur Chalekian GEPC

    Like

  5. Nobel Prize winner Shiller warns of a market bubble

    Fears of a bear market for U.S stock markets came back to the fore recently with Nobel Prize-winning economist Robert Shiller PhD warning of rock-bottom investor sentiment in his latest research.

    http://www.msn.com/en-us/money/markets/nobel-prize-winner-shiller-warns-of-market-bubble/ar-AAegDvR?li=AA4Zjn&ocid=iehp

    Other economists may agree:

    http://www.msn.com/en-us/money/markets/mark-your-calendars-economists-see-next-us-recession-in-2018/ar-AAeaRFE?li=AA4Zjn&ocid=iehp

    And, even more … it will be UGLY:

    http://www.msn.com/en-us/money/markets/a-worst-case-scenario-for-stocks-its-ugly/ar-AAe8Cyk?li=AA4Zjn&ocid=iehp

    Jade

    Like

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