How to Protect and Build Wealth During a Market Correction
Can the stock market good times keep going indefinitely?
Not according to a new report from researchers at Deutsche Bank.
The data involved is enough to give any investor pause. Deutsche Bank reminds us that we're nearly 1,000 days out from the most recent market correction.
A correction is typically defined as ten-percent drop in a brief period of time. According to data gathered by Deutsche Bank researchers, the average term between corrections historically has been 357 trading days. Today we're nearly 600 days beyond that mark.
Deutsche Bank analysts haven't explicitly said a correction is looming. They are, however, ringing a warning bell. The bank's strategists have said they believe there is a "high probability" of a dip of at least five-percent this summer.
So how should we prepare for an impending correction? And is there any way to turn it to our benefit?
Running of the bulls
It's human nature to think in terms of streaks and probability. If a coin turns up heads nine times in a row, we tend to think the odds are overwhelming the tenth flip will be tails. Yet that's not the case. Each coin flip is an independent event. The tenth flip is a 50/50 proposition, just like the previous nine.
Just because the market's hot streak is much longer than usual doesn't mean a correction is preordained. Yet there are other rumblings of distress in the system.
First, the U.S. economy has not met growth expectations this year. Corporate earnings have also been sluggish. With stocks also looking a bit expensive, the conditions seem riper than ever for the first correction in years.
Deutsche Bank suggests several additional risk factors that have the potential to serve as a triggering mechanism for a substantial sell off. The Federal Reserve could err when determining when to hike interest rates. The Fed's interest rate policies have propped up the market for years. Unless the increase is expertly managed, the fallout could be considerable. A booming U.S. dollar and a surging bond market could also complicate matters.
Making the best of a correction
While the prospect of a correction isn't exactly something to relish, there are steps you can take to smooth the ride. Deutsche Bank suggests taking a close look at your portfolio. Avoid the temptation to sell and instead look for discounted stocks to buy. A correction doesn't signal the end of a bull market. Stock prices often recover quickly post-correction. This may provide some excellent short-term trading options.
It's a good idea to research ahead of time. Make a list of stocks you'd like to buy when the price comes down. When the correction hits, you'll be ready to move. Not every stock is created equal in this environment, however. Deutsche Bank suggests avoiding consumer companies facing tough competition.
If you're an investor waiting on the sidelines for post-correction bargains, you might want to reconsider. Sure, that strategy sounds logical. Yet if you wait too long, prices will continue to rise, eating into any potential discount. Buying during a correction also isn't for the faint of heart. It takes real follow through to buy when everyone else panics. Pulling the trigger may be more difficult than you think.
It's important to remember that stock market corrections are inevitable. Historically, it typically takes just a few months for the market to recover. That means you shouldn't pay attention to media hysteria. Take the long view. Know that dips are part of the process. Far from being a disaster, they can often be turned to your advantage. Knee jerk reactions are the worst possible outcome.
While corrections may drive news coverage, the reality is that there is nothing inherently special about a 10-percent drop. Corrections of five-percent usually happen several times each year, according to Goldman Sachs research. It's part of the market's natural volatility. Too often we make the mistake of imposing a narrative where none exists.
The bottom line is simple. The stock market is hard to predict in the short term. Yet it's very predictable over long periods of time. Any investor who internalizes this idea will be well ahead of the game.