Too High?

Far more money has been lost in preparing for corrections than in the actual corrections.” – Peter Lynch

Investors, particularly those who have been through previous (2001, 2004, 2008) market declines, are beginning to feel skittish.  The reasons for this mainly revolve around the current all-time highs of the Dow Jones Industrial Average and the S&P 500, as well as the length (5 years) of the current bull market.  I intend not to refute this fear, but instead to put it into perspective:

  1. Since 1960, the S&P 500 has hit a new closing high over 800 times; that works out to about once every 16 trading days.
  2. Since the end of World War II, there have been 27 corrections of more than 10%, and an additional 12 bear markets (greater than 20%); that works out to about one correction every 21 months.  Their average decline was 13%, and the length is about 3 months.
  3. In the same time, there have been 58 bull market rallies in between corrections, and they tend to last about 8 months, with an average increase of 30%.
  4. Corrections are regular and necessary occurrences.  Like a forest fire, they create a cleansing and an opportunity.
  5. We most recently had a correction in 2011: from April to September, the Dow dropped 16%, and the S&P dropped right at 20% (that would technically be a bear market, meaning we are 2 ½ years into a bull market; we can argue about that another day).

What does all of this mean?

  1. The stock market may or may not be too high right now.
  2. There will be a 10% or greater correction at some point in the near future.
  3. Everyone’s definition of near is different.
  4. We don’t have a crystal ball.

What do we do in anticipation of this?

  1. Have sufficient cash on hand so that you can ignore the volatility in your long-term investments.
  2. Rebalance!  Because of the recent run-up, your equities are likely a higher percentage than they ought to be.
  3. On that note, if you have a sizable percentage of your portfolio in one stock, or one sector, you need to diversify.  If it is in a taxable account, be sure to include your tax professional in the discussion.
  4. If there is a significant decline, and you have excess cash, consider buying at the low…
  5. There is no way to know what the low is, but that doesn’t make point #4 moot.
  6. And, lastly, stick with your long-term investment objective(s).  If you haven’t updated these in a while, talk to me and I will make sure that you are properly positioned to deal with unexpected downturns.
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