Market Corrections Are Healthy
Key Points – Market Corrections Are Healthy
- Why Are Market Corrections Healthy?
- Building a Diversified and Balanced Investment Portfolio
- Keeping a Long-Term Investing Approach
- Reviewing Other Historic Market Corrections
- 5-Minute Read | 23-Minute Watch
Avoiding the Emotions of Fear and Greed When Investing
Given what happened to the markets on Monday, August 5,1 we figured this would be a fitting time to discuss market corrections and why they’re healthy. The market sell-off saw declines in all three of the major U.S. indices. The Dow Jones Industrial Average fell 1,033.99 points, losing 2.6%. The S&P 500 fell 160.23 points, losing 3%. And the Nasdaq composite fell 576.08 points, losing 3.4%.
Fear of loss is typically the first emotion that tends to kick in for many people during market sell-offs. On the flip side of that, it can be easy for investors to become greedy when the markets have significant gains in a short period. Acting upon the emotions of fear and greed can make you susceptible to a great deal of market risk. Every market correction or bear market should serve as a reminder that it’s important to have a diversified and balanced investment portfolio.
What Led to the Market Sell-Off on August 5?
There were several factors that were linked to the severe market downturn earlier this month.2 Those factors included concerns about economy, corporate earnings, and how the Federal Reserve has handled the unwinding of global currency trading. Our Director of Investments Stephen Tuckwood, CFA, specifically noted these events as potential factors
- Wednesday, July 31
- Bank of Japan raised its benchmark rate (moved to 0.25%).3
- The Fed indicated no change to its benchmark rate but opened the door for a first rate cut in September (currently 5.50%).4
- Friday, August 2
- Nikkei 225 dropping by 5.8%, but from all-time highs.5
- Monday, August 5
Unwinding of the Yen Carry Trade
Let’s touch a little bit more on the winding of global currency trading, specifically as it concerns the Yen compared the U.S. dollar. The Yen recently reached a multi-decade low versus the USD, as trades borrowed Yen to buy USD denominated assets. A carry trade means buying a high-interest-rate currency (long the USD) against a low-interest-rate currency (short the Yen).
When the Bank of Japan started to raise its benchmark rate on July 31, and the Fed hinted that it might lower its benchmark rate, the forex markets reacted to the directional convergence and began to unwind the “Yen/USD Carry Trade.7” The unwinding of this overcrowded trade cascaded into a broader unwind of risk assets.
Tuck once again mentioned in our July Monthly Economic Update that the U.S. and global economy have been slowing, but not aggressively. Also of note, the July jobs report was weak, but wasn’t cause for too much concern. That cemented the case for the Fed to start cutting rates in September.
Look at What Happened After the Market Correction on August 5
We can’t stress enough how critical it is to maintain a long-term investment approach. Yes, market corrections can be painful, but they are also normal and healthy. Even after the big market correction on August 5, the S&P 500 ended the week essentially flat.8 Last week was an example of market volatility 101.
Market volatility can be very unsettling, especially because it’s something that’s out of your control. Instead of making a knee-jerk reaction type of decision following a significant market correction, you can plan for those type of events.
When our team builds financial plans, we stress test them to see how they would fare during more prolonged market downturns, high inflation, high interest rates, and other economic cycles that could impact your long-term financial goals. Having a financial plan that’s been stress tested is mentioned several times throughout our Retirement Plan Checklist. Take some time to review this white paper to begin gauging your ability to get to and through retirement.
Other Reminders of Why Market Corrections Are Healthy
As we wrap up this article about market corrections, let’s look back at some other historic days in the stock market.
Black Monday
The market sell-off on August 5 drew comparisons to October 19, 1987 (a.k.a., Black Monday). Black Monday was one of the most significant market crashes in history, as the Dow Jones Industrial Average fell 22.6% in one trading session.9 Despite the big losses on Black Monday, stocks quickly recovered and finished slightly up at year’s end. One of our managing directors, Dean Barber, remembers Black Monday and the ensuing stock market recovery well, as October 19, 1987, was his first day in the wealth management industry.
Dot-Com Bubble
Let’s look at a couple of events that are more recent as well: the Dot-Com Bubble and COVID Crash. The 1990s featured strong economic growth throughout much of the decade prior to the Dot-Com Bubble bursting in early 2000. The tech-heavy Nasdaq experienced exponential growth during the second half of the 1990s but lost 75% of its value from March 2000 to October 2022.10 That was another example of why having a traditional balanced portfolio is important rather than tilting it heavily toward one asset class or sector of the market.
COVID Crash
Markets were at all-time highs when COVID-19 hit in 2020 and still ended the year at all-time highs despite an unprecedented market crash. The Dow Jones Industrial Average and S&P 500 lost 37% and 34%, respectively, during the crash.11 However, the Dow Jones Industrial Average grew 43% after that and the S&P 500 still ended 2020 up 15.6%.
The COVID crash marked an end of an 11-year bull market run, which started with the recovery from the Great Recession. While no one could’ve predicted the fallout of the COVID crash, there were indicators of a bear market correction prior to the pandemic, as the yield curve began inverting in 2019. Patience and proper portfolio diversification were once again pivotal during the rollercoaster year that was 2020.
What’s Next?
Mark Twain is frequently attributed to the famous quote, “History doesn’t repeat itself, but it often rhymes.12” Our team has found that to be the case with market corrections. The scenarios we’ve mentioned are all different in their own way yet have an underlying theme.
August 5 was the most recent reminder that market corrections are healthy. We’ve mentioned a few times over the past year that treasury bonds have been due to be a true portfolio diversifier. That long wait has brought changes, which is good news for people with traditional balanced portfolios.
Market corrections will continue to be necessary to help avoid systemic bubbles. It’s important to us that your portfolio is structured in such a way that it can withstand and endure the inevitable volatility that comes with investing.
We want to make sure that you have a financial plan that can guide you to make informed decisions with your money and understand the financial implications that can arise during market corrections. If you have any questions about the latest market correction and how your portfolio is structured, start a conversation with us below.
Resources Mentioned in This Article
- The Fine Line Between Good Fear and Bad Fear
- What Should I Invest My Money in?
- What Is Market Risk?
- Bear Markets and Mean Reversions
- Proper Portfolio Construction with Stephen Tuckwood, CFA
- Can the Fed Hits Its 2% Inflation Target?
- Components of a Complete Financial Plan with Logan DeGraeve, CFP®, AIF®
- Stress Testing Your Financial Plan
- 10 Ways to Fight Inflation in Retirement
- The Effect of Rising Interest Rates on the Economy
- Short-Term, Mid-Term, and Long-Term Financial Goals
- Reviewing Your Retirement Checklist
- The Dot-Com Bubble Remains Relevant
- The Great Recession’s History Remains Relevant
- From Quantitative Easing to Quantitative Tightening
- What Is Yield Curve Inversion?
- Market Sentiment and Inflation’s Impact with David Mitchell
Downloads
Other Sources
[1] https://apnews.com/article/wall-street-stocks-dow-nasdaq-873f1109d279176e847bff278f178af9
[3] https://apnews.com/article/japan-economy-rates-boj-yen-e00919b053412fabf7a800ed78a9ad7a
[4] https://www.federalreserve.gov/newsevents/pressreleases/monetary20240731a.htm
[5] https://www.cnn.com/2024/08/02/business/japan-nikkei-225-rates-investors-intl-hnk/index.html
[6] https://www.cnbc.com/2024/08/04/stock-market-today-live-updates.html
[9] https://www.bankrate.com/investing/biggest-stock-market-crashes-in-us-history/
[10] https://corporatefinanceinstitute.com/resources/career-map/sell-side/capital-markets/dotcom-bubble/
[11] https://www.thestreet.com/dictionary/covid-19-stock-market-crash-of-2020
Investment advisory services offered through Modern Wealth Management, Inc., a Registered Investment Adviser.
The views expressed represent the opinion of Modern Wealth Management a Registered Investment Advisor. Information provided is for illustrative purposes only and does not constitute investment, tax, or legal advice. Modern Wealth Management does not accept any liability for the use of the information discussed. Consult with a qualified financial, legal, or tax professional prior to taking any action.