A correction is a beautiful thing, simply the flip side of a rally, big or small. Theoretically, corrections adjust equity prices to their actual value or “support levels”. In reality, it may be 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 holders rarely take profits but often take losses. Additionally, the new breed of Index Fund speculators is ready for a reality check. If this brief hiccup becomes a full blown correction, new investment opportunities will be abundant.
Here’s a list of ten things to think about doing, or to avoid doing, during corrections of any magnitude:
1. Your present Asset Allocation is based upon long-term goals and objectives. Resist the urge to decrease your Equity allocation because you expect lower stock prices. That would be an attempt to time the market. Asset allocation decisions should have nothing to do with stock market expectations.
2. Take a 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 Investment Grade Value Stocks as they move lower in price. I start shopping at 20% below the 52-week high water mark… the shelves are full of bargains.
3. Don’t hoard the “smart cash” you accumulated during the rally, and don’t get yourself agitated if you buy some issues too soon. There are no crystal balls, and no place for hindsight in an investment strategy. Buying too soon, and selling too soon is investing brilliance.
4. Take a look at the future; you can’t tell when the rally will resume or how long it will last. If you are buying IGVSI equities now, you will to love the next rally even more than the last… with yet another round of profits.
5. As the correction continues, buy more slowly as opposed to more quickly, and establish new positions incompletely. Hope for a short and steep decline, but prepare for a long one. There’s more to “Shop at The Gap” than meets the eye, and you should run out of cash well before the new rally begins.
6. Your use of “Smart Cash” proves the wisdom of Market Cycle Investment Management; it should be gone while the market is still falling… gets less scary every time. So long your cash flow continues unabated, the change in market value is just scary, not income (or life) threatening.
7. Note that your Working Capital is still growing in spite of falling market values, and examine holdings for opportunities to reduce cost basis per share or to increase yield on income Closed End Funds). Examine fundamentals and price; lean hard on your experience; don’t force the issue.
8. 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 media hype and propaganda. Focus on Investment Grade Value Stocks; it’s easier, less risky, and better for your peace of mind.
9. Examine portfolio performance with your asset allocation and investment objectives in focus and in terms of market/interest rate cycles as opposed to calendar quarters and years. The Working Capital Model allows for your personal asset allocation.
Remember. too, that there is really no single index number to use for comparison purposes with a properly designed MCIM portfolio.
10. So long as everything is “down”, there is nothing to worry about. Downgraded (or simply lazy) portfolio holdings should NOT be discarded during general or group specific weakness. BUT, you must have the courage to cull them during rallies… also general or sector specifical (sic).
Corrections (of all types) will vary in depth and duration, and both characteristics are clearly visible only in institutional rear view mirrors. The short and deep ones are most lovable (kind of like men, I’m told); the long and slow ones are more difficult to deal with.
If you overthink the environment or overcook the research, you’ll miss the party.
Stock Market realities need to be dealt with quickly, decisively, and with zero hindsight. Because amid all of the uncertainty, there is one indisputable fact that reads equally well in either market direction:
There has never been a correction or a rally that has not succumbed to the next rally or correction..