What to do in a correction?

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S&P500 down 4%, stocks hitting 52-week lows, Emerging markets sell-off, NASDAQ seeing its worst day since 2011, global growth slowing, interest rates rising!!!

 

The past few weeks have given investors many reasons to panic and lose faith in the equity markets. The increased volatility and mixed market conditions have led to investors fearing for their capital. Just when they thought they had seen a breezy summer, investors were hit with a sea of red.

The S&P500 is now down 7.3% month-to-date, with two separate six-day losing streaks, something that had not been witnessed since November 2016. Major indices like the Dow industrials and S&P500 erased their 2018 gains. NASDAQ entered into correction territory, as it was down 10% from its most recent peak. The iShares Emerging Markets (EEM) is down 16.7% year-to-date.

Sectors that are seeing the worst performance are Tech, Growth, and Consumer-discretionary. Tech names are down 10.8% month-to-date, Growth stocks are down 11.7% month-to-date, and Consumer Discretionary names are down 12.3% month-to-date.

 

Recent stumbles seen in 2018

This is now the third time in 2018 that the markets have entered “correction territory”. The first was a fast and hard downturn in late January, where S&P500 lost 10 percent in just ten days. This was due to concerns over a slowdown in Chinese economic growth. The second happened in the last week of March when the DOW and S&P500 pulled back 5.7% and 5.9%, respectively, while the Nasdaq dropped 6.5%. This pullback was largely due to the possibility of a trade war between the two biggest economies, the US and China. Tech companies and bank stocks were under pressure. For example, Facebook dropped 13.8% due to the Cambridge Analytica scandal and Bank of America pulled back 4.5%. The economic fundamentals were still strong in the US and corporate earnings remained intact. This week, we saw some of the worst days in the market since 2011. Heavy losses in global stocks added to the rolling ball of increased sell-off and panic. Worries of economic situation, trade wars, slowing Chinese growth and interest rate hikes led to the Dow shedding more than 600 points, wiping out the gains for the year.

 

Intact Corporate Earnings:

Underlying fundamentals such as corporate earnings haven’t changed much. Companies are still beating estimates and generating value. McDonald’s reported earnings of $2.10 per share vs $1.99 EPS estimates. Deutsche Bank’s Q3 net profit came in at 229 million euros vs 149 million expected. Barclays beat its Q3 net income estimates by reporting one billion pounds vs 723 million expected. Boeing reported earning of $3.58 per share vs $3.47 EPS expected. In addition to these, many other names have also beaten estimates and are growing. So the worries of slowed down growth might be exaggerated depending on where one looks.

 

What history is telling us?

Here is a quick summary of market downturns going back to 1928 courtesy of ‘A Wealth of Common Sense’. As you can see, information like this gives a clearer, more accurate idea of what is maybe a more likely outcome in a downturn. While everyone is looking at a small data set in statistical terms, the likelihood of this being the next crash is probably pretty low. Since the possibility of a correction, crash or entering the bear market always exist, an investor should at least be prepared for the possibility, even if they do not expect it.  Here are a few ways we suggest investors can keep their calm:

 

Don’t panic

It doesn’t feel great, but this is normal. View it as a chance to rebalance and/or take advantage of those opportunities that have been in a watchlist.

 

Be proactive, not reactive

As mentioned before, sell-offs in the market that send investors panicking does no good. If you own quality stocks with strong revenues, cash flow and market fundamentals, things should work out over the long term for companies who have seen this movie before.

 

Ignore the noise (if you can)

Every twitter guru, blogger, and TV show are likely predicting impending doom. Pull up a long-term chart of the S&P 500 and hopefully find some solace that 10 years from now, you will barely be able to point out this correction in a chart. Think long-term.

 

How to protect yourself:

 

Buying during a correction of any size is a smart idea/dollar cost averaging

Taking new positions or adding to existing positions during market dips can be a smart idea. Historically since 2009, the market has recovered from corrections within weeks or months. A high-quality stock with strong fundamentals trading at a discounted price can increase in value over time.

 

Reevaluate your investment portfolio

Investors should now take their time to reassess their portfolio. Of course, when the stock market is reaching new highs, it is easy to forego this and jump on the train. Take this as an opportunity to look at ones holdings, why you hold it and if it is doing what you expected it to (or at least if you are comfortable and understand the volatility it is seeing) The current increased volatility in the market presents the right time to reevaluate your strategy and check if it can still hold water. If it doesn’t for any investment, it may be time to consider selling.

 

Add dividend stocks

Dividend stocks have historically proven themselves during market corrections and through market cycles (or else they likely wouldn’t be paying a dividend). A dividend isn’t issued unless their boards of directors have a positive outlook for the company and can foresee the continuation of dividend payments. Invest in reliable-dividend paying stocks and consider reinvesting your dividends into faster capital growth opportunities during corrections. 

 

Hopefully, reading this has helped calm your nerves regarding the equity market volatility. If you are invested in the markets, be prepared to feel the heat. Patience and long-term investments have been the keys so far for successful individuals. Do your due diligence, study the markets, understand the financials and keep your emotions at bay.

 

Happy investing! 

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