No one can accurately predict when the stock market is going to correct itself.
Still, the lack of truly reliable information to predict a market correction shouldn’t stop us from planning ahead. As investors, we should have our investment plan in place and follow our other plans in life like when we’re planning to visit a foreign country or how we plan to remodel our kitchen or bathroom.
A part of my plan for investing is to try and be aware when opportunities present themselves. An investment opportunity is the ability to buy an investment at a favorable price. This can easily take place at the time of a market correction.
And sometimes you’ll be able to see signs of a possible market correction waiting to happen. Planning ahead and staying prepared can help us as investors deal with the stress and anxiety that can come with a market correction.
Companies Reducing Dividend Payments
The payment of a dividend is basically a reward to the shareholder for being an investor. It’s not an obligation, but an option for the company to pay a dividend. And it usually happens when times are good (i.e. the company is profiting from sales).
If more and more companies reduce or worse, stop paying dividends all together that means they are not able to generate enough sales to put forth a profit large enough to pay a portion to its shareholders.
Reduction of dividend payments can result in less desire for investment in the company and a lower stock price. And if news comes out of more and more companies reducing their dividend payments, the overall market index (e.g. S&P 500) will generally fall.
Wild And Continuous Ups And Downs In The Market
Remember the corrections that took place back in February 2018? It corrected by about 10%. And part of it was the classic case of investor worries due to inflation concerns. The wild and continuous ups and downs continued for a couple of months. Check out the S&P chart below from the end of January 2018 to the end of September 2018 when it arguably looks the market is stabilizing a bit:
It shows that corrections can easily take place with the mass perception of a likely event. But the market can and will recover
Inflated Shiller Price To Earnings Ratio
The Price to Earnings or PE Ratio is simply a measurement of the value of the stock market. And as the old saying goes, what goes up must come down. The key question is how far up does it go before it starts tumbling down?
The Shiller PE Ratio also is known as the Cyclically Adjusted P/E or CAPE Ratio uses 10-year data that is smoothed out to account for fluctuations in the business cycle. Experts say that it’s better to use the Shiller PE to understand market valuation.
Check out the Shiller PE Ratio data obtained from Quandl:
And here is the summary of the peaks and the difference in years.
|Peak Year||Years Elapsed|
This just simply means that a rise and drop took place within the PE Shiller on average every 11 years. Therefore, one can make the argument that we are due for a drop of the PE Shiller ratio very soon since, according to the data we are at the brink of a market correction, that is 11 years have passed.
Factors Indirectly Related To The Market May Become Related
2008 Housing Crisis – in a very simplistic form, many people were not able to pay their mortgages because they either took on a loan they couldn’t afford in the first place or the mortgage payment itself sky-rocked due to an adjustment in their interest rate or a mixture of things. This caused financial companies to suffer and spiraled to other sectors and the overall stock market.
Additionally, author of The History of the United States in Five Crashes, Scott Nations says that this housing crisis was the catalyst of the Great Recession of 2008. His book analyzes each of the stock market crashes over the past 100 years and claims that each one is related to an “external catalyst” that leads to an eventual market crash.
Terrorist Attack – at the time of the September 11, 2001, terrorist attacks, the stock market closed and remained that way for a week. It reopened with over a 10% loss, mostly attributed to uncertainty and panic. However, the economy is resilient and the market recovered quickly to its original levels, within one month.
Natural Disaster – surprisingly, natural disasters have not affected the stock market much. For example, Hurricane Katrina which occurred in 2005 did not affect the market much, less than a 3% change took place in the S&P 500.
The earthquake in California on January 17, 1994, resulted in growth within the state’s economy. This was due to the rebuilding efforts and growth in GDP. The S&P 500 closed at 473 points on 1/17/1994 and closed at 481 points on 1/31/1994.
Therefore, some natural disasters have provided a boost in the economy and overall market.
When Times Are Tough, Do The Opposite
Despite the corrections that will inevitably take place, if you’re a long-term investor, you should not panic. Yes, that is easier said than done. But here are some tips to avoid panicking.
- Cut back on reading and listening to the news. I know it sounds crazy, but it’s the job of media outlets to report practically every piece of news they can get their hands on. And if a piece of new seems bad, that doesn’t mean it really is bad.
For example, let’s say a company in which you own stock was going through a rough patch and decided to lay off 100 employees and consolidate a couple of offices. It’s definitely unfortunate for the employees.
But remember, as a stockholder, the company is taking responsible action to prevent further losses and optimize its business in the hopes for greater profitability in the future.
- Think long-term and remind yourself of your investment plan. Long-term investors should remember that their strategy focuses on the time in the market, NOT timing the market. Heck, for long-term investors, a correction should be viewed as a positive thing because you are buying investments at a lower price point.
- Don’t be afraid to deploy more into the market. Here again, you are buying at lower prices. In anticipation of a correction, try to save up some money so that you can seize the opportunity the market will present to you.
Join The Discussion:
- Do you have plans for when the market crashes or corrects?
- Is your investment plan to continue what you are doing?
- How much of a correction do you predict in the S&P 500 (10%, 15%, 20%)?
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