There’s been a Market Correction, Should you be Worried?

 When investing, for every fairy tale stock like an Amazon(AMZN) or Nvidia(NVDA), there’s an equally disastrous stock like MoSys(MOSY) or Gevo (GEVO). To avoid getting into stocks like these, it’s important to look at their failures and analyze them to avoid getting into the next potential train wreck of a stock

Should you be Scared of the Dow’s 1700 point drop?

On the fifth of February 2018 the Dow Jones Industrial Average saw its largest single day drop in history. This drop coming off a market sell-off at the end of January has caused many investors to call for the start of a bear market. Are these claims well founded, or just good headlines?

Firstly, dollar amounts are likely the worst way to look at market changes as they skew the data. In 1929 the Dow fell from around 300 to 230. A 70 point move means nothing in today’s market environment. Just because the 1700 point drop is the largest point drop in history it doesn’t mean it is the worst drop. If you look at it from a percentage viewpoint, the markets dropped 23% in those two days in 1929. (Conversely), the “biggest point drop in history”, and the drop the day before, has only moved the market down by 6%.

What does a 6% drop typically mean for medium-large companies?

Since Indices are made up of a collection of companies, what does a 6% drop over two days typically signal for medium to large companies over the past twenty years?

That view would be a bit concerning to the average investor, and confusing for those not familiar with Equities Lab. Stocks purchased in the dark green line – and labeled Poor Performers Any Time – are all medium to large size companies who have suffered a 6% drop within two days bought on a monthly basis. The purple line – labeled Buying the Dip – are all medium to large size companies who have suffered a 6% drop within two days bought on a monthly basis only when the Dow has dropped by 6% over two days within the last month before the rebalance. The bright green lines – labeled screener – are all medium to large stocks that have dropped 6% within two days and purchased on a monthly basis as long as the Dow hadn’t dropped by 6% over two days within the last month before the rebalance.

Now, neither of these charts is pretty. That said, they do give us valuable insight into how the market operates and when you should exit. In market turmoil it appears that it is far better to remain in the market and weather the storm than to sell out whenever the market dips.

What about a market correction?

A market correction is viewed as a 10% move downward from the previous high. As of the eighth of February we have experienced a “market correction”, but is that something to be worried about?

Using the dividend adjusted $DIA index ETF we can count how many times the Dow has been corrected. This should, in theory, tell us just how severe this problem is and whether we should be afraid of an impending bear market.

Of the 49 times the Dow corrected 25 of them happened during the Great Recession of 2008, 20 happened in the early 2000’s just before the burst of the dotcom bubble, and the rest were peppered in the time between 2012 and today.  The fact that the Dow doesn’t exhibit this type of volatility often, and that it has only happened during large economic downturns or periods of market unrest could be a warning sign. The same can be said for $SPY which has exhibited roughly the same number of drops at similar points during the stated time period. All that said, the Dow has pushed forward – especially in recent years – regardless of a correction. The market is going to continue to charge ahead like a bull.

There has been a correction, should you sell off your portfolio?

Our gut always tells us to sell off our portfolio in the event of a down market. Losing money hurts and we fear that things will continue to get worse, so we sell – but should you?

If we were somehow able to create a portfolio with the entire market of companies with a market cap of greater than $2b and rebalanced that portfolio every year on January 1st we would end with the following.

The portfolio returned 9.38% annually for a total return of 501% over the past 19 years. Decent returns that outpace the dividend-adjusted returns of the $DIA. Nothing too exciting, but your portfolio will ride both the ups and the downs. Now, what happens if you decide to sell off your existing portfolio whenever there is a market correction and don’t buy back in until your next rebalance period?

Surprisingly your returns are a lot worse.  Rather than returning 9% annually your portfolio will only see about 5% in annual growth. If you sell out during a market correction your portfolio will undoubtedly be liquidated at a loss. However, if you hold on and wait for the market to swing back around, which it has always done over the long-term in the entire history of the market, you can make your money back and more. Have a plan, stick to it, and long live the bull market.

 

About Tyler McCain

A student of finance at Georgia State University, Tyler has had a passion for the world of finance for as long as he can remember. Joining the Equities Lab team in 2015 he attempts to juggle the perfect mix of school, work, and giving back to the community. When he isn't working at Equities Lab he can often be found helping teach programs at the Rosen Family Foundation - a non-profit that teaches financial literacy to middle and high school students.

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