Insights & Advice

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Market Corrections are a Necessary Evil

Over the last few weeks, the stock market has become “breaking” news. The headlines, the talking heads, and even the politicians are solemnly pontificating on what credit tightening, sub prime lending and falling world markets means to you and me.

My take is much simpler and a lot less stressful. We are having a market correction, period. Corrections are as natural to financial markets as the beginning of fall is to the end of summer. Corrections lower our expectations, remind us of risk, reset prices to more reasonable levels and bring all of us more in line with reality. We don’t like them, some of us may even hate them but they are necessary.

There have been 87 corrections in the benchmark U.S. stock index called the Standard & Poor’s 500 since 1928. That works out to a bit more than one per year. On average they last about four months although recently they have been over in half that time. This one, by the time you read this, should be about 75 days old.

Most market experts classify a correction as a decline in prices of 10% or more. This summer the S&P has lost 9.4%, which is close enough for me. Could it fall further, of course it could but that’s the beauty of the markets, no one knows until it happens. Does that make your stomach lurch? If it does, take comfort. Since 1946 it has only taken the market from peak to trough and back to its pre-correction peak a little over 100 days to recover. If you are, like me, a long -term investor, then three plus months should be barely a blip on your time horizon.

If you can’t stand the heat for that long you either are not diversified properly (remember: stocks, bonds and cash) or you don’t belong in the kitchen at all. Markets can be erratic and subject to many starts and stops. Corrections, like most of life, adhere to that old adage two steps forward, one step back.

But, as usual and on schedule, the talking heads are warning that this time may be different. Just before the commercial they pose this question:

“What if this isn’t just a correction, what if this time there is a global melt down based on mortgage problems and credit tightening that creates the Big One, or maybe even the dreaded “D” word?”

You sit dutifully waiting for their wisdom, a sinking feeling in your gut, only to hear.

“ We’ll be right back after this word from our sponsor.”

It works more often than not but by the end of the show you still don’t know. I sympathize. During every correction since 1981, I have had to endure these same armies of doomsayers spewing mountains of learned commentary on exactly why we are undergoing a correction and what it could mean if this or that happens. Enough already.

A case in point is last summer, if you recall, we suffered a 9% decline in the U.S. stock market in August. It was painful but it was a necessary evil. Can you remember why we had that correction? No? Well, how about the corrections in 1997, 1998, or 1999? The point is that most of us have no idea why markets correct, nor is it important. What is important is that the markets are self-correcting mechanisms, which reduce speculative excesses and restore us to sanity. We don’t like them but we need them and we are better off because of them. If all else fails, think of them this way: without corrections, markets cannot go higher so hang in there for this too shall pass.

Posted in A Few Dollars More, Macroeconomics