Correction Introspection.

August 27, 2013

Investors? Fickle folk.
Three weeks ago, as the S&P 500 hit an all-time high of 1709, investors were euphoric. CNBC's finance fox, Maria Bartiromo, prowled the trading floor of the NYSE as ebullient traders applauded the market's historic close.
Newsletter writers speculated on the exciting upside portended by a new market high. Wall Street wooed. Clients cooed. All was well in the world.
Today, roughly 4.4 percent beneath that heady high, the tone has changed.
Volatility is up. Investor confidence is down. And money is being pulled from equity funds as if someone got a tip from God.
Settle down, people. Four-and-one-half percent does not a correction make.
By definition, a correction typically involves a 10 percent pullback. We are still short of that level. Fifty-six percent short, in fact.
Since World War II's culmination, the stock market has incurred 27 corrections of 10 percent or more. In other words, true stock-market corrections have occurred every 20 months, on average. Twenty-five percent having occurred during the 70's disco days. Twenty percent took place during the secular bear market of 2000 to 2010.
Full-blown bear markets? These involve market pullbacks of 20 percent or more. These grizzly bears are rarer than their smaller, less volatile brethren. Since WWII, markets have experienced 12.
The average market decline during these 27 10-percent corrections has been 13.3 percent. On average, they've occurred over a 71-day period. That's market days, so just over three months.
Secular bull markets can run roughshod for extended periods without much drama. 1982 to 1987 saw one correction. 1987 to March of 2000? Just two. And since the market hit bottom in March of 2009, there have been only three corrections: spring of 2010 (69 days, -16%), summer of 2011 (154 days, -20%, but rebounded quickly), and the spring of 2012 (60 days, -9.9%, almost a correction).
In between corrections, the market can experience bull-market rallies. Having had 58 such occurrences post-WWII. They tend to run for an average of 221 trading days. And rise an average of 32 percent. Accordingly, we are way overdue for a correction. Have been, for some time.
Corrections represent on opportunity to pick up coveted positions you wish you'd purchased earlier. Accordingly, they are your chance to sell less-coveted companies.
For those with a five-year time horizon, corrections represent a time during which you tightly grip the steering wheel and wait for blue skies. For those with less than five-year horizons, you should not have been invested in equities to begin with.
Corrections, as well as bear markets, feel terrible while they are occurring. Yet, they are the market's natural mechanism for clearing out the chafe. As forest fires are nature's harsh way of destroying viruses and other harmful elements, so do market corrections eradicate bad habits, bad companies and bad advice.
Consider that market corrections rarely give way to full-blown bear markets. Yet, they can. And on occasion, do. At that point, your downside protection parameters should come into play (trailing stops, hedges, inverse, per your preference). If you have no downside protection parameters, you're playing with fire. Or dealing with an advisor who is extremely acclimated to the heat. At least with your money.
Why do we ride roller coasters? Not because they consistently go up. The thrill, which is the reason we ride, is provided by the disparate topography of the ride. It goes up. And down. Doing both sufficiently well enough to coerce thousands to stand in line for hours.
Markets are no different. Without the dips and drops, the higher elevations would not be so enjoyable.
So buckle up and keep your hands inside the car.

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