By Tim Courtney, Chief Investment Officer
From September 2 through 21, the S&P 500 fell about 4%. For the month through yesterday, the S&P is down a little less than 2%. This kind of market behavior over the course of a month is unremarkable. However, because of the speed of the market’s rise over the last year and a half with a lack of much downside, investors have seemed more nervous during this pullback and several analysts have called for a near-term stock market correction.1
We have market corrections about once every 18 months on average, so it would not be surprising if we had one now. The fact that we haven’t had one is probably more surprising given the market surge since March 23, 2020. The S&P 500 has doubled from its trough last year,2 which it’s done before within 18 months but never without corrections within the run higher. We nearly had a correction last September but the market fell just shy of a full 10% pullback.
That said, corrections do serve a purpose and are healthy for markets. Like buildings constructed with a foundation and temporary scaffolding as the building grows higher, markets grow higher on a fundamental foundation and supports. The higher the market moves, the market scaffolding that has built up around it can become less stable.
A correction can be seen as taking down scaffolding and replacing it with a stronger, more solid frame for long-term investors. During this market rally we have seen speculation in certain areas, especially in meme stocks and SPACs. Much of this has been driven by record amounts of account margin and leverage being used. Note the large increase in those who have left their jobs and become full-time day traders.3 Corrections are useful in clearing out some of the excesses and speculation from markets.
History has shown that it is very difficult to predict corrections, and those credited with correct predictions rarely do so more than once in a row.4 One thing we can do, however, is rebalance portfolios. Times in which markets have run and investors have become overweighted to stocks compared to their planned allocation (77% actual vs. 70% target, for example), we can take some of the gains and rebalance them into other assets. This ties our actions back to the planning and overall strategy investors decided upon when the portfolio was started.
J.P. Morgan supposedly once said, “In bear markets, stocks return to their rightful owners.”5 This is a reference to those investors who, like us, are longer-term investors and may be willing to put additional capital to work as prices are dropping. Corrections are not fun, but they are necessary and whenever they may occur, we should expect stocks and the profits they generate to return to their rightful owners.
If you have any questions about this or rebalancing your portfolio, please reach out to your Exencial advisor.
Sources:
1. CNBC (9/20/21) — U.S. stocks bounce slightly as it tries to claw back from Monday’s rout
2. CNBC (8/16/21) — S&P 500 doubles from its pandemic bottom, marking the fastest bull market rally since WWII
3. CNBC (09/21/2020) – Many are chasing the stock market by day trading in the pandemic. It could end badly.
4. Forbes (10/11/18) — Can we predict when a market correction is due?
5. The Orange County Register (6/10/06) — How a plunge returns stocks to ‘rightful owners’
The S&P 500® is widely regarded as the best single gauge of large-cap U.S. equities. There is over USD 9.9 trillion indexed or benchmarked to the index, with indexed assets comprising approximately USD 3.4 trillion of this total. The index includes 500 leading companies and covers approximately 80% of available market capitalization.
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