Making The Most of Market Corrections

Whenever there is market turbulence, especially a downdraft, I get asked what I think of it and what people should do to respond. While the standard response is to “do nothing,” I think that there are some opportunities that underpin that statement. Planning for and anticipating complications is a big part of my medical practice (intensive care). Also, one of the toughest actions to take is deliberate inaction. Especially when action usually means interesting diagnostics and procedures. A double check that you have the basics covered often yields the most benefit.

The most recent scary narratives and market turbulence revolve around unstable economic arrhythmias emanating from the big ventricle to our south. The irritable focus changes with every market correction. Learn how to anticipate and act to make the most of them when they do appear. Don’t be shocked – it is better to be prepared and in control of the defibrillator.

Expect Market Corrections

In medicine, we do “code drills” and simulations. Why? Because when you respond to real cardiac arrests, they are scary. There is chaos that you must reign in, pick out the vital aspects to act on, and avoid the errors from acting on the noise. People perform better under pressure if they have prepared. That means anticipating what it may look like and considering what the most important data signal is amongst the noise. Markets are full of short-term noise, with a signal that can only be seen over the long term. Below is over 120 years of US market data to show this. There are several key messages in it.

---

Market Corrections Are Frequent & Normal

Corrections of 10-20% occur every 1-2 years and usually last 3-9 months from peak to peak. That feels like an eternity, and it feels new every time. Smaller dips of 5-10% were too small in the big picture for me to highlight without using a size 2 font, and I surely missed flagging some of the 10% drops. The current “correction” as of writing this has been ~10% for US markets. It has been a couple of years since the last one. Enough time to forget. And also to miss out on about 35% of upside if you had sold when the SP500 dropped 10% in early 2022. Over 60% if you sold at the bottom when things were scariest about 10 months into the last correction.

---

It Always Feels Bad & Different

The current borderline correction probably feels worse than 10% because of the fear that comes with the narratives. The narratives are pervasive. Tariffs and the political rhetoric to accompany them have been discussed in the media and at the dinner table. Even if you tell yourself that you can ignore the market, it is tough when it is discussed everywhere, even if you don’t watch CNBC or BNN or log into your accounts.

But we are in unprecedented times! We always think that, and it is part of our human bias/ego. The preceding chart is packed with 120 years of unprecedented catastrophes: Two world wars, two global pandemics, and the election of Trump twice. There have been countless local conflicts, 9/11, Y2K, the Great Depression, and The Global Financial crisis. The Cuban Missile Crisis and other nuclear threats of the Cold War. The ozone layer and climate change. There is always something. Much of it is major – especially when it touches our daily lives. However, that chart still goes from the bottom left to the top right. Humans, markets, and economies adapt and move forward. That is the long-term signal.

---

Use The Above to Anchor Yourself

Knowing the above can help you. Keep perspective by knowing to expect corrections every year or two. They should not surprise you. Consider what your portfolio would look like with a 10% and 20% drop. With an actual dollar figure. Couple that with the expectation that it will happen. Acclimatize yourself to it.

That helps, but you will still be naturally drawn to the moment’s narrative. Keep the above chart handy and remind yourself of all the other calamities that markets have weathered. They were all headlines and dominated conversations in their time.

Secular Bear Markets

Market corrections of 10-20% are pretty routine. Some drops even exceed 20%. If they are short-lived, like under a year or so, they may be cyclical bear markets within a secular bull market. Scary, but manageable if you can ride the year out. However, a secular bear market can have an important impact if it hits you at the wrong time. A secular bear market may take years or even decades before recovering to touch new highs. Our investment lifetime is measured in decades. By the time compounding has worked its magic, we may only have a few decades left. That sounds really scary.

---

What if this is just the beginning?

The tough part is that you can’t know whether the market is in a cyclical or secular bear market until it is over and new highs are reached. What if this is just the beginning of the next secular bear market? What if this is the bottom and you don’t want to miss the ride back up? If you knew the answers, the logical action would be easy. But you don’t. Whatever information makes you think one way or the other is already priced in.

Markets could go down further. They could violently recover with unexpected positive developments. The strongest days are often clustered around the worst days and missing them can have a large impact. You cannot know the future in advance. So, buying or selling based on news is illogical. Doing that based on your gut-feeling about the future is usually dead wrong. We are emotionally wired to sell when scared (like on the worst days) and miss the up-days. To make matters worse, those rip-your-face-off rallies tend to cluster around the worst days.

---

What To Tell Yourself

Someone may trot out a chart like the one I just showed and say something along the lines of, “Look, if this is the beginning of a bear market your wealth will drop by half and it won’t recover for 10 years!” A so-called lost decade. While that is good for grabbing your attention, fortunately, that is not usually what investors experience in real life. Why? Because you don’t just buy or sell your portfolio all at once. As a bear market unfolds over time, we buy and sell based on our cash flow.

That means as prices drop, if we are in the accumulation stage, we continue to buy more shares. So, when the market recovers to break even, you are actually ahead. You bought shares at a discount all the way down and on the way back up. When the price per share hits its previous high, you have more money because you have more shares. When the market drops, tell yourself that you are buying shares at a discount. Again, don’t wait for a sale. Getting 20% off after a 50% advance is not a deal. Just buy regularly when you have the money. Sitting on cash to buy the dip or when the market drops a certain amount also loses on average.

Another useful antidote to the hyperbolic prophesies of doom when you think you are staring into the abyss are two logical exercises. First, if markets keep dropping and you are the last one buying – you will own everything! Second, if that doesn’t matter because the financial order has disintegrated, then your portfolio doesn’t matter. Guns, ammo, and toilette paper will be the likely currency.

Actions To Take

We are pretty much guaranteed to live through some nasty secular bear markets. They occur every 5-20 years or so. I have covered a few reasons why they should not be as scary as they seem. Factoring them into your planning can also help you live through them. Market correction are a routine part of investing. The most common advice is to “do nothing” because of that. However, acknowledging how difficult that is for “people of action” and that market corrections do present an opportunity, here are some actions that you can take.

---

Anchor Yourself

Re-read this post and look at the pictures. Know that corrections and bear markets are expected. Consider what that looks like for your portfolio to acclimatize yourself. Remind yourself that the narratives and predictions you hear are known and the probability of them happening is priced in by the efficient market. That pricing is heavily weighted towards the institutions with better access to information than you, and they have lightening reflexes. Do not make decisions based on “news”. It is known.

---

Check The Crack of the Couch

You shouldn’t sit on cash you plan to invest waiting for the market to bottom or buy the dip. Statistically that is a losing strategy. However, when people are freaking out, pretend they are freaking out because it is a Black Friday door-crashing sale.

Check the crack of the couch (and your accounts) to make sure that you aren’t accidentally sitting on uninvested money. Take advantage of the sale.

---

Reflect on Your Job Security

If you are worried about your financial security because of your current cash flow rather than what markets are doing, that is very important. It is easy to ignore when things are going well. However, an economic downturn can bring vulnerabilities into focus. You cannot stick to a long-term investment plan if you don’t have a stable financial platform.

You must have enough saved for your near-term needs. That may only need to be enough to cover unexpected expenses if you have a rock-stable job. However, you may need to plan for a job loss if the bad news shaking the markets may impact your employment. If you job is secure, knowing that you can cover your costs of living independent of the market and continually adding to your portfolio is soothing.

---

Reflect on Your Retirement Plan

If you are approaching or in retirement, do you have enough to see you through a bear market? Hopefully, you have made a plan and stress tested it. If not, then this is a good cue to get on that. It is one of the areas where even a DIY enthusiast could benefit from professional planning software and a second opinion that goes with it.

You may have more than enough financial buffer in your portfolio coupled to enough flexibility in your spending to weather even the worst bear market. If so, knowing that will help you spend with confidence. Vital for a happy retirement. On the other hand, there may be areas that you can tweak to make your plan more robust. It is better to figure that out in advance to make the necessary changes less dramatic. You want to be able to take advantage of distressed sales of some nice stuff on Kijiji. Not be on the other side.

---

Do You Have The Right Asset Allocation?

People often ask about changing their asset allocation when there is market turbulence. That could be their stock to bond mix, based on the predictions of where either may move in response to the disruption. It could be to over or underweight different geographic markets or sectors based on where ground zero of the crisis lies. Making changes based on how you think the crisis will unfold is a bad idea for the reasons already mentioned. You can’t predict the future and those stories are priced in.

However, there may be good reasons to change your asset allocation. For example, if you realize that your job is less stable and less “bond-like” – maybe you need to add some bonds or money-market funds to buffer yourself. Conversely, perhaps you are in a strong position, and after experiencing some rough waters, have more confidence and capacity to take advantage of a down market.

After analyzing your position and getting a taste of some market nastiness, you may realize that you don’t want to or need to take as much risk. We can do multiple exercises to try and estimate our risk tolerance and choose a matching asset allocation. However, the best test is how you feel and react during market volatility and a bear market.

Your risk capacity and tolerance can also change over time. So, use this as a chance to reflect and make gentle adjustments. If you decide to change your asset allocation due to a change in your circumstances, steer it like a ship and not a Sea-Doo.

---

Are You Diversified?

Sometimes a market correction is precipitated by a systemic event that hits all asset classes. Except maybe toilette paper. However, there are often areas that are hit less hard or may even benefit. The best we can do is diversify to mitigate the risks that we can. For example, in the current correction, the S&P 500 is down about 5% YTD in $CAD. In contrast, Non-North American Developed Markets are up ~10% YTD. A globally diversified all-in-one equity ETF, like XEQT/ZEQT/VEQT, is down about 1% YTD. Diversification at work.

You cannot predict which part of the world will lead at any given time. Leadership shifts around and you don’t know when that will happen. Just buy the whole world. Choose an asset allocation that makes sense and rebalance it about once per year. You don’t need to be precise, but you should be mechanical. Or use an ETF that does it all for you. Make the most of a market correction by using it to motivate you to diversify if you haven’t already and rebalance if your portfolio has drifted too far off course.