After years of being bull, on February 5th, the stock market finally took a tumble. It was the first of a series of up and down nail-biting days for investors that finally ended up with the market doing what financial experts call a correction.
In a two-day period, the Dow dropped over 1,800 points with similar downfalls on the Nasdaq and S&P 500, but what does all that mean for the average person with an IRA or stock investment?
Now is not the time to panic. Instead, take a breath as the industry does what it inevitably has to do — make a correction. But, what exactly is a market correction, and how will it affect stock prices in the future?
A stock market correction is not the same thing a crash – such as the one investors saw in 2008. February 5th did represent the largest single-day point loss in history, but it came after a time of excess ups in the market – sort of cushioning the blow.
A stock market correction is simply a negative movement in the three major stock indexes. The downward movement must equal to 10 percent or more based on the recent highs. This has happened a total of 37 times in U.S. history, including the most recent correction in February.
Now, let’s compare that to the most recent crash in 2008. At that point, the U.S. financial system was near collapse, and the S&P 500 had dropped almost 50 percent in value. With the minor correction seen in February of this year, the S&P 500 lost only 7.8 percent of its value — not even technically in correction territory. The Dow average about 8.5 percent below and the Nasdaq just 7.2 percent. The actual dip into correction territory was very short before the market began to recover.
What investors need to keep in mind is that mild corrections are common. Two things caught the public’s eye with this particular correction, making it more newsworthy. First, it’s been a bull market for almost two years without the typical ups and downs. Second, there was a drastic single day drop — the worst in U.S. history.
You already know corrections are common, yet, people continue to invest in the market. Why? The simple answer is because corrections are short and have little impact on long-term investment strategies. The day trader or short-term players gets hurt by this type of correction, but that is not how most people invest. The truth is when you buy into the market, you should do it for the long-haul.
Although stock market corrections are common, they are also somewhat unpredictable. Different things tend to trigger them. The 2008 collapse is attributed to an explosion of subprime mortgages that derailed the housing market. In hindsight, it seems like someone should have seen that coming, but the fact that they didn’t should tell you something. There are enough variables that it is not possible to know when a correction will occur. A financial crystal ball would certainly make things easier, but it is all speculation until under something happens.
Not only should you hold off on making any major changes to your portfolio as a knee-jerk reaction to a correction, it’s a practical time to consider expanding your investments. In February of 2016, Bank of America stock was trading at just 12 dollars after a market correction. Today, it is up to 30-plus. Look at high-quality stocks that drop and consider building on what you have as a long-term investment.
It’s a good time to look over your current holdings, too, to see if they still make sense. Maybe you took advantage of a low stock during the last correction and it hasn’t performed well. Don’t be afraid to make a few smart changes if you can use those funds for a better quality stock after a correction.
The moral of this story is that corrections happen. What is unusual is the lack of corrections for the last couple years. Make long-term investments and then ride the wave until retirement. A small correction like this recent drop is not a reason to panic if that is the strategy you use to build your portfolio.
Regards,
Ethan Warrick
Editor
Wealth Authority
