A correction is a beautiful thing, simply the flip side of a rally, big or small. Theoretically, even technically I'm told, corrections adjust equity prices to their actual value or "support levels". In reality, it's much 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 (and sector/index derivatives) out there than ever before. And therein lies the core of correctional beauty!
Mutual Fund unit holders rarely take profits but often take losses. Additionally, the new breed of Index Fund Speculators over-react to news of any kind because that's what speculators do. Thus, if this brief little hiccup becomes considerably more serious, 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 should be tuned in to your long-term goals and objectives. Resist the urge to decrease your Equity allocation because you expect a further fall in stock prices. That would be an attempt to time the market, which is (rather obviously) impossible. 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 high quality, dividend paying, NYSE companies as they move lower in price - Investment Grade Value Stocks (IGVS). I start shopping at 20% below the 52-week high water mark - the bargain bins are far from full.
3. Don't hoard that "smart cash" you accumulated during the rally, and don't look back and get yourself agitated because you might buy some issues too soon. There are no crystal balls, and no place for hindsight in an investment strategy. Buying too soon, in the right portfolio percentage, is nearly as important to long-term investment success as selling too soon is during rallies.
4. Take a look at the future. Nope, you can't tell when the rally will resume or how long it will last. If you are buying quality equities now (surprisingly few Investment Grade Value Stocks are at buying levels as this is being edited) you will be able to love the rally even more than you did the last time - as you take yet another round of profits. Smiles broaden with each new realized gain, especially when most Wall Streeters are still just scratchin' their heads.
5. As (or if) the correction continues, buy more slowly as opposed to more quickly, and establish new positions incompletely (higher quality equity CEFs are great vehicles for this strategy). 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 if you are doing it properly, you'll run out of cash well before the new rally begins... but, your income should keep rolling in for monthly position additions.
6. Your understanding and use of the "Smart Cash" concept has proven the wisdom of "The Investor's Creed" (look "them" up). You should be out of cash while the market is still correcting - it gets less scary each time. As long your cash flow continues unabated, the change in market value is merely a perceptual issue.
7. Note that your "Working Capital" is still growing, in spite of falling prices, and examine your holdings for opportunities to average down on cost per share or to increase yield (on your "income purpose" securities). Examine both fundamentals and price, lean hard on your experience, and don't force the issue... remember, income CEFs may allow you to buy illiquid income securities at discount prices.
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 what the Wall Street propaganda mill spits out. Focus on IGVS, it's just easier, as well as being less risky, and better for your peace of mind. Just think where you would be today had you heeded this advice years ago.
9. Examine your portfolio's performance: with your asset allocation and investment objectives clearly in focus; in terms of market and interest rate cycles as opposed to calendar Quarters (never do that) and Years; and only with the use of the Working Capital Model (look this up also), because it is based upon your personal asset allocation. Remember, there is really no single index number to use for comparison purposes with a properly designed portfolio.
The Market Cycle Investment Management (MCIM) process implements all of the thoughts expressed in this article.
10. So long as everything in your "markets" is down, there is nothing to worry about. Downgraded (or simply lazy) portfolio holdings should not be discarded during general or group specific weakness. Unless of course, you don't have the courage to get rid of 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 grade rear view mirrors. The short and deep ones are most lovable; the long and slow ones are more difficult to deal with. So if you over think the environment or over cook the research, you'll miss the party.
Unlike many things in life, 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/rally that has not succumbed to the next rally/correction.
NOTE: Versions of this article have been published since the 1980's... some things never change.
