The markets continue to slide deeper into correction territory, which is defined as about a 10 or 20% drop from an all-time high. But before I dive any deeper into my thoughts, let’s level set some terminology, starting with market correction.
Market Correction: This is defined as a drop of at least 10% (but not quite 20%) for an index off of its high. We got here on Thursday after a pretty steep sell-off.
Bear Market: A bear market is defined as a 20% or more decline in stock prices or a stock index.
Now I know that no stats or frequencies or amount of time to recover will ever make an investor feel good about the current correction, or even a bear market, but they do set some expectations to help everyone understand what we’re most likely dealing with.
So first, let’s review some statistics* surrounding a market correction—again, by definition this is when an index drops by over 10%, but not quite 20%, off of an all-time high. On average, we see a market correction about once a year, and they usually last three to four months. The average market loss during a market correction is somewhere around 13.3%, and the worst loss in a market correction by definition is 20% (because that’s when a market correction becomes a bear market), and the smallest loss obviously by definition is 10%.
So now let’s talk about a bear market. This is by definition anytime that the market drops by over 20% from its all-time high. This usually happens on average every three and a half years. Historically, they have lasted about 10 months, with an average market loss of about 35%.
Now the worst loss during a bear market was 1931, where the bear market resulted in a 62% loss while the smallest loss was 21% and that was recorded in 1949. In a bear market, the average time to recover is somewhere around 22 months so essentially two years. Bear markets usually happen due to some sort of fundamental reasons such as a recession or a lending bubble. You think about 2002 with the exuberant market valuations, or high interest rates can do it, too.
So here are some things to know about a market correction. These usually happen around once a year. They also tend to happen for no specific reason or based on some sort of news event like we saw back in December of 2018 if we remember that, or even today. Market corrections rarely last that long. In fact, they tend to average somewhere between three and four months in length. They also take another three to four months to recover. So after a period of let’s say six to eight months from the start of a correction to the end of correction, the stocks have generally fully recovered. Again, that’s on average. Also, market corrections should really only be a matter for short term traders and not for long term investors. In most market corrections, there’s a really sharp recovery with very little bottom building or retracing. And what that means is that recoveries tend to be swift and steep, and stock market correction is often a good time to pick up high quality companies at an attractive valuation. See my last video where I talked about Warren Buffett.
Here’s what we recommend people do during market corrections. First, don’t make hasty decisions. Patience and discipline and focusing on the long term rather than the short term tends to help investors more than anything else. I know it’s hard to do, given the news and everything, and the severity of the sell-off, but in a world of “do something”, never underestimate the power of “do nothing”, as the best way to actually do something.
Another thing to keep in mind is that the market’s recovery will probably come sooner rather than later, unless the economic situation changes, which would shift us into a bear market. And frankly, this could. But I believe that it’s actually what’s causing this. What if this causes a recession? What if this really impacts corporate earnings? And that’s what’s happening, I think.
So if we do shift into a bear market, it will take some good news and some better economic conditions to spark a recovery out of a bear market. Again, if that happens the markets will recover and that tends to happen when the news starts to look good again. This is why we rely on our MONCON Recession Model—because MONCON will never call the exact bottom of a market (to start raising cash) nor will it catch the very top (to deploy back in). But it does a good enough job to keep us from making emotional decisions in a correction and provides some protection by raising cash well before the bottom.
Remember no one on March of 2009 thought it would be the best time to get back into the market, and it wasn’t until way, way, way later than people who said, “Oh, I just want to wait until things get better” actually got back into the market. This is why as an investor, identifying your cash needs well in advance of conditions like now is so important. No one who raised cash in January for projects or living needs, has to worry about raising cash now, and probably/hopefully won’t have to for 12 to 18 months, which increases the probability that a recovery happens well in advance of their next cash raise window. We believe in our broken record of having a plan that incorporates for environments like now, and in our conviction that cash is always the best hedge against volatility and market conditions like now. [See: Lifetime Milestones and the Power of Time]
Most people know that famous scene from Apocalypse Now where Robert Duvall’s character, Lieutenant Colonel Billy Kilgore says, “I love the smell of napalm in the morning. It smells like victory.” But it’s actually his line afterwards that I think is one of the best parts of the whole scene as mortar shells fall and explode around on this beach, he’s seen kneeling, shirtless, wearing nothing but his trousers, his dog tags, and that iconic Stetson hat. And he’s talking to Martin Sheen’s character, a Special Operations Army Captain named Ben Willard. And Captain Willard is seen in his full combat equipment—he’s got his helmet, his weapons, his Flak Jacket, the whole thing. It’s a total dichotomy—the older infantry officer being this Cavalier guy while the younger Special Forces Captain is hunkered down with all this gear, and when Lieutenant Kilgore pauses right after that victory line he says this: “Someday, this war is going to end.”
Someday, this current sell-off is going to end. But over the short term, no one can possibly know what’s next. However, like, the confident Lieutenant Colonel Kilgore, I can tell you that this will come to an end. And over the long term, portfolios will recover and surpass even the most recent high. Short term reactions are nothing more than guessing and it’s impossible to be a good guesser. So don’t try to be the good guesser, rather, be good at the guessing game, which I outlined last week in my blog.
Market recoveries will come sooner than you expect. So, because of that, don’t try to time this market bottom. Again, recoveries tend to be sharp and quick and people who try to time in and out of the market may miss a significant rebound. Despite all the corrections and bear markets, equities have fared the best in the long run. Remember that the S&P 500 has returned a compounded annual growth rate of close to 9%–not only over the past 10 years, but also over the past 20 years. So it pays to be a long-term investor and leave the trading to others.
Call us with any questions that you have, any concerns you have, and I hope this gives everyone an idea of how we’re viewing this current market condition.
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*Statistics above pulled from Seeking Alpha’s February 27, 2020 High Dividend Opportunities Market Update by Rida Morwa.
Please remember that past performance may not be indicative of future results. Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product (including the investments and/or investment strategies recommended or undertaken by Monument Wealth Management), or any non-investment related content, made reference to directly or indirectly in this blog will be profitable, equal any corresponding indicated historical performance level(s), be suitable for your portfolio or individual situation, or prove successful.
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