Sarah Travers
Despite facing a year filled with daunting challenges such as surging inflation, rising interest rates, and even the unsettling specter of bank failures, the financial markets have demonstrated remarkable resilience. Notably, the S&P 500 has surged by approximately 16% year-to-date, while the Nasdaq Composite has enjoyed gains of around 33%.
This unexpected turn of events has defied earlier predictions of a recession and a stagnant stock market in 2023. However, as we navigate this uncertain landscape, investors are reminded of the importance of readiness in the face of potential market corrections.
Deciphering Market Fluctuations
Market participants frequently encounter terms like “correction,” “crash,” and “bear market,” all of which signify declines in stock markets. A correction is characterized by a downturn of at least 10% but less than 20% over a specific period. In contrast, a crash is a sudden and steep drop, often exceeding 10%, occurring over a brief timeframe. Bear markets, like the one observed in 2022, entail declines of over 20% that persist for several months or even longer.
It is crucial to note that corrections typically do not escalate into bear markets. They often occur suddenly and recover swiftly, causing minimal long-term damage.
Triggers Behind Market Adjustments
One of the primary triggers for market corrections is overvaluation. This was strikingly evident in 2021 when an overheated stock market bubble burst, leading to a correction. Subsequently, factors such as inflation, supply chain disruptions, and geopolitical tensions contributed to an extended period of market decline.
Key indicators, such as the S&P 500’s price-to-earnings (P/E) ratio, currently standing at around 20 for the trailing 12 months, suggest that the market is not currently overvalued. The Fear and Greed Index, which measures investor sentiment, is in neutral territory, indicating a fairly priced market. However, macroeconomic factors such as inflation, high interest rates, supply chain issues, and unemployment still possess the potential to trigger corrections.
Steering Through Market Volatility
Long-term investors should view corrections as temporary events that do not necessitate panic selling.
To build a resilient portfolio, consider investing in robust businesses with consistent earnings and revenue growth while diversifying. Diversification entails including not only aggressive growth stocks but also large-cap value stocks, which tend to perform better during market declines. Expanding investments across various industries and market cap sizes can help mitigate losses during corrections.
While specific cases, like recent banking turmoil, may warrant selling affected companies, avoid impulsive panic selling. Instead, smart investors often seize opportunities to buy during sharp market drops, capitalizing on quality companies at more favorable prices.
