A stock market correction is coming. Just ignore it.
This is guidance for a lifetime of investing as much as it is for rough days like Wednesday and the months ahead. Anxiety-free stock market investing is a dream that will never come true.
If ever there was a time to decide whether you're cut out for stocks, it's today. Markets have soared off their lows of four years ago, but the outlook remains bright if you believe the global economy is struggling but capable of rebounding. There's still time to get into the market for the long term, but prepare yourself for a lot of talk about a pending correction.
A correction, generally defined as a pullback of 10 per cent or more, is a natural, non-catastrophic occurrence after a strong market runup. The Canadian stock market is revisiting its 1990s role as a global mediocrity right now, but the U.S. market has been red hot. The S&P 500 stock index was up 10 per cent for the year through April 2, and gained 16 per cent last year.
Watching the market give up some of its gains is always painful, but the losses in recent pullbacks have had a minimal impact on longer-term results. The wealth management firm TriDelta Financial says in its latest note to clients that the S&P 500 fell 15 per cent at one point in 2010, but ended the year with a gain of more than 10 per cent. In 2012, the index turned in a 10-per-cent decline before ending up with a big year-over-year gain.
TriDelta president Ted Rechtshaffen said clients are asking him these days whether he thinks a correction is possible. He replies with a yes, which invites the question of what the firm is going to do about it. "Well, we do have a little bit of cash that we're hoping to use, but other than that we're going to ride it out," Mr. Rechtshaffen said he tells his clients. "Over all, we think things are good."
His reasoning starts with the view that there's more upside for the markets than we've yet seen. The U.S. economy appears to be gaining strength, and interest rates are low and will remain so for a while yet. Stocks have come way back, but only after a long period of poor performance. Looking back five years, the S&P's annualized gain has been a relatively tepid 3.5 per cent.
There's certainly stuff to worry about as an investor, though. For example, the recent events in Cyprus raise concerns about other indebted European countries. As part of a rescue plan for the Cypriot banking system, bondholders and wealthier depositors will have to bear some losses. Expect the stock markets to react with horror if the same were to happen in much larger countries such as Italy or Spain.
The massive U.S. debt is another concern, as is the extent to which the current stock market rally has been fuelled not by rising corporate profits but by the U.S. Federal Reserve Board's use of low interest rates as an economic steroid. Worries like these coalesce into scary outlooks like the one you'll find in a new book called called The Great Deformation: The Corruption of Capitalism in America.
The book was written by David Stockman, a former aide to U.S. president Ronald Reagan, and it argues that the economic policies of the past several decades have brought the United States close to collapse. At the end of an opinion piece Mr. Stockman wrote last week for the Sunday edition of The New York Times, he advised readers to get out of the markets and hide out in cash.
Rebuttals to Mr. Stockman have come from all over the economic and political spectrum (check out my Tuesday blog post for more detail: http://tgam.ca/Douu), but doomsday outlooks are unavoidable in today's world. Think of them as a counterbalance to the mega-bullish outlooks we always see at market peaks.
If you opt out of stocks in response to today's uncertainties, be sure to check whether you'll need to save more to compensate for the low returns of bonds and guaranteed investment certificates. Investors who commit to stocks should buy in gradually and let diversification be their shield against the correction that is for now, and always, around the corner.
Four Rules For Investors
1) Ignore talk about bond and dividend stock bubbles: You need bonds in your portfolio for stability when stock markets fall, and dividend-paying stocks are a solid foundation for investors.
2) Don't get cute with bonds: Corporate bonds are fine, but high yield and emerging market bonds should get only a tiny weighting in your portfolio at most; you get enough risk from the stock market without adding more through your bond holdings.
3) Stagger your stock market investments over the rest of the year: You'll limit your vulnerability to a correction that way, and have some money working for you if stocks keep going up.
4) Think globally: Most investors have plenty of Canadian content and are underweight on U.S. and international stocks.