You’ve probably heard the news. The market declined on Monday, February 5, with the Dow Jones Industrial Average losing 1,175 points to close at 24,325. The media touted it as the largest single-day point decline in stock market history. Though the headline is true, the overall pull-back amounted to a 4.6% decline. A true market correction is considered a drop of 10% or more, generally resulting in a decline between 10 and 20%. The media may have evoked fear that the market is failing, and that is not necessarily true.
Some perspective on the drop
Despite the ominous sound of the news, the stock market decline was a very normal correction in an always shifting stock market, in which prices had risen to high valuations.
The bull stock market has long been in need of a correction to adjust for stocks that were overvalued. Price to earnings (P/E) ratios have crept to an all-time high. The P/E ratio is the amount an investor is willing to pay for $1 of the company’s earnings, so the higher the ratio the more expensive the stock price. After a correction, like the one experienced on Monday, stock market values can be knocked down so that they are more realistic and in alignment with true market value.
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Why corrections are good
A correction in the stock market is often the result of fearful behavior among investors and there are a few reasons why people would act out of fear. At the end of 2017, the United States Federal Reserve said that Americans could expect three interest rate hikes in 2018. Now that we’re in 2018, that realization could be evoking emotional investing. We also have a new chair for the Federal Reserve, so people may be uneasy about what this means for the stock market, perhaps assuming that the new chair, Jerome Powell, may alter the path taken by his predecessor, Janet Yellen. These are just two possible reasons for the correction, but there are many other factors that could create declines in the market, such as geo-political crises, automated algorithms that buy or sell stocks based on data points, or unfavorable company earnings.
The benefit of a correction is that people who were in the inflated market can profit by selling or cashing in some or all of their stock gains before the downturn, and those who have cash or less money to invest can buy shares at lower prices after the downturn, bringing an influx of fresh money into the markets and an opportunity for future savings growth. This is a good thing for the markets overall and a great thing for newer investors. As a matter of fact, investors swooped back in to the market just one day after the biggest decline to snap up buying opportunities and the market swung back up by over 500 points.
Should you do something?
When you are invested in the stock market, whether you’ve got money in individual equities, mutual funds, or exchange-traded funds (ETFs), you’re investing for the long term. A 10% loss may not be significant in the short run if your investing horizon is long-term. The stock market pendulum is always going to swing between highs and lows over a period of time. Historically over time, the market has always gone “up” when the pendulum settles. For those who are invested in the stock market, you may have lost what you had gained during the first month of the year. Stay on track and focus on your long-term investing goals and objectives.
If your retirement horizon is one, two, or even five years in the future, you may want to get in touch with your financial advisor to discuss options. Preserving the wealth you have accumulated for your golden years should be part of your overall planning. Otherwise, stay calm. The stock market is always going to have an element of choppiness or volatility. Stick to your plan and rest assured things will be ok.
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