It is all too easy to get caught up in the euphoria of optimism when we’re in the midst of a bull market. A solid domestic landscape has propelled strong returns. Since the bottom of the last market correction after the global financial crisis, the All Ords accumulation index has risen more than 160 per cent, the US Dow total return index has surged over 300 per cent and the broad global MSCI index is up more than 230 per cent.
However, such environments can often lull investors into believing that the current trend will continue unabated. Experienced investors will tell you that the only certain thing about markets is that they are uncertain and that the bulls simply won’t run forever.
Not that I want to cause a state of panic. At Lincoln Indicators, we encourage investors to be fully prepared for, and take full advantage of, the next major market correction when it occurs.
What does history tell us?
Anecdotally, history has shown that most 20 per cent plus corrections occur after significant bull market runs, and although low-interest rates, the wall of money flowing into superannuation and the rise in popularity of exchange traded funds have helped the market recently, who knows what will happen next? In the US, the current bull market is more than eight years old. It is the second longest in history and the third best performer. History and the law of averages would suggest we may not be far from the next major market correction.
But don’t be downcast. It is about staying the course and not trying to time such events. Listening to the noise in the marketplace can cause us to act irrationally and make panicked decisions. For example, we had plenty of reasons to stay out of the market in the last financial year. The Brexit vote, Donald Trump’s presidential election win or a return to a rising interest rate cycle were all cited as reasons to stay away from the sharemarket. But this action would have cost you significantly given the recent market performance.
Being forewarned is forearmed when it comes to investing. Being prepared for all circumstances, including a possible correction today, will take the emotion out of making decisions. In fact, it will provide you with the clarity and confidence to navigate and take advantage of such an event when it occurs.
Steps to manage a market correction:
1. Get your asset allocation to shares right
While the recent market run is pleasing, it can tilt our portfolios outside of their ideal allocation. Now may be a great time to rebalance back to your desired asset mix. An appropriate allocation to shares for an investor will be a function of their stage of life, their objectives from investing and their attitude to risk.
2. Have the confidence to ride through the cycle
Once you’re comfortable with the money “at risk” in the market, then have the confidence to ride through any correction, provided you are comfortable with the quality of stocks you are holding. This will ensure that not only will those stocks survive any market correction, they will be the first to rebound once the market regains its sanity. Having a defined investment strategy that helps you identify fundamentally healthy businesses will help keep your emotions in check in order to make confident decisions.
3. Volatility creates opportunity
While many share investors fear volatility, it should be embraced, as it is a key reason why equities are the best performing asset class over the long run. While volatility can lead to short-term losses, if harnessed correctly, it can be a wealth generator for those brave enough to seize it. Any irrational selling, particularly in financially healthy businesses, should be an opportunity to buy stocks at bargain prices.
Focus on getting your asset allocation right and being armed with the appropriate stocks for all conditions. You’re then ready to seize the next opportunity the market will inevitably throw at you.