One certainty in the stock market is short-term volatility. Volatility—both positive and negative—is bound to happen eventually and can be nerve-racking when it hits. Imagine facing a sudden and steep drop of 10% or more in your stock portfolio. Naturally, such declines can be downright terrifying, especially to retirees who already fear running out of money in retirement.
Nobody enjoys watching these huge and fast drops in their portfolio values, especially when they have grown accustomed to the growth associated with a bull market. But one thing to remember about market corrections is they are typically sentiment-driven drops that lack any fundamental causes. These fears make up the proverbial “wall of worry” investors must climb during a bull market. And like a compressed spring, the harder the market gets pushed down in a downturn (whether short-term correction or longer downturn), the stronger the bounce.
Rather than reacting to each drop in stock prices, you may better off focusing on your longer-term investment strategy in order to meet your retirement goals. Regardless of how long and strong a downturn may be, the following bull market is generally longer and stronger.
Corrections are sharp, short-term market declines of 10% or more that typically occur amid a larger bull market. They are often attributable to psychological factors and false fears rather than economic fundamentals. Hence, their effect on the market tends to be fleeting.
Although corrections are a common feature in virtually every bull market, they still throw many investors off course. This can be attributed to the mixed messages sent off by the financial media or the uncertainty that comes with market volatility.
Perhaps the most unnerving part of a correction is that they can strike for no or any reason at all. Not only are they impossible to time with any degree of accuracy or consistency, but they are just as difficult to anticipate or prepare for.
So, what is the best way to handle a correction? We believe it is best to simply ride it out rather than attempt to sidestep it. If you exit the market during a correction, you run the risk of missing out on the V-shaped recovery that tends to occur immediately afterwards. And this can set you further back in meeting your financial goals than if you had just stuck out the volatility.
The other kind of market downturn is a bear market—a fundamentally driven stock market drop of 20% or more. While you may be able to sidestep parts of a bear market, you still bear the responsibility of deciding when to get back into the market to participate in the rebound. Missing the initial rebound—whether bear or correction—can be incredibly costly.
After a downturn, stocks tend to bounce back quickly and vigorously. The shape of this event—the plunge and subsequent recovery—takes the form of a V. Hence, we call the pattern “V-bounce.”
You can see the V-bounce repeated throughout stock market history, from corrections in bull markets to the emergence of new bull markets following a bear market.
Exhibit 1: Hypothetical V-Bounce
Note: For illustrative purposes only. Not drawn to scale. Not to be interpreted as a forecast.
Before a V-bounce, investors are most concerned with the losses on left side of the V. This is where investor sentiment is at its lowest, where the majority of the investing public is fearful and where selling can be most intense. It is also the point where many investors have exited the markets, and where even seasoned investors may have to fight the temptation to give in and call it quits.
Once investors start to panic and media negativity peaks, the first signs of a recovery often start to appear. As counterintuitive as it may seem, the market often rebounds just when all hope is lost. As painful as the losses of a correction or bear market can be, you don’t want to be sitting on the sidelines when the market starts to recover.
The right side of the V is where the market bounces back, where the investing public floods in to invest and where resilient investors are rewarded for having nerves of steel. Think of it as a depressed spring. The more you push down, the bigger the potential bounce back!
Dealing with market volatility is difficult for even the most seasoned investors. For investors who exited the market amidst a downturn, deciding when to get back in can be just as nerve-racking. When a downturn hits the market, it may be best not to overthink it and to stay invested, sticking to your longer-term investment strategy.
If you would like to learn more about how Fisher Investments can help you deal with market volatility, whether correction or bear market, contact us today.