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Corrections, Capitulation, and Confidence

Corrections, Capitulation, and Confidence

January 31, 2022

Given the backdrop of the financial markets lately, we thought providing some soothing commentary would go a long way in replacing panic with patience. The market, marked by the S & P 500, has pulled back 10% from the recent highs with the technology weighted Nasdaq index falling over 15% over since the beginning of November.  A correction is often cited as being a 10% pullback from recent highs in a given financial security.  More uniquely, we have seen a deterioration of high growth stocks even more so with names that broke out higher during the pandemic (see image) correcting drastically!  

High growth equity valuations have deteriorated due to rates being expected to rise.  Higher rates increase the discount factor of companies' growth expectations back to today's dollars more rapidly.  Most recently the Fed Chairman, Jerome Powell, stated that the Fed would be reactive to economic conditions and lingering inflation with their rate policy.  Most members of the Fed are agreeing that as many as 4 rate hikes could happen later this year.  As your investment advisors, we know the experience of this correction has not been fun.  Trust us, it isn't fun for us either.  When panic begins to be the dominating sentiment moving equity markets, it's easy to feel anxious and somewhat remorseful.  These feelings are compounded when you focus on the short term, instead of elongating your time horizon.

Our job is to keep these feelings at bay and stop them from transforming into poorly made decisions.  Poor decisions like selling unanimously throughout your portfolio, trying new trading strategies, and over managing your portfolio only add to the panic in the market.  Panic leads to capitulation.  At the beginning of the Covid-19 pandemic we authored a blog on 'Capitulation'. We urge you to give that blog a read and think about your emotions along that chart before continuing this blog.

A healthy series of steps to take to start building mental confidence and investment fortitude after a correction:

1) look at other corrections you've navigated through previously, and remember how you felt then and how you weathered that storm too:

2) assess what follows corrections on a historical basis

One thing we know is that equity markets don't go straight upward or downward along a steady trend.  The trend is 2 steps forward, 1 step backwards, 5 steps forward 3 steps backwards etc. Given this fact, after a large decline in equity prices over a relatively short period of time we look for bases to be built. A base is characterized as any consolidation in price action (a tightening of price action). Generally, we look for bases after an overall market correction to take 7-10 weeks of time. The base is built by prices consolidating between the most previous high, and market low after the correction. 

Given the numbers we've seen already we are looking for the S & P 500 to base between 4818 (recent highs) and 4222 (recent lows).  Holding the prior lows of January 24th is key in determining if a base is sustained. 

3) make sure your long-term financial plan has not changed and focus on how your portfolio is just one piece of your entire financial security

Some of the first questions we ask our clients if they call-in worried after a market correction is, 'has your risk tolerance changed?' and 'has your lifestyle changed or needs changed?'  

Most of the time the answer is no.  Upon ensuring that our goals are the same as they were prior to the correction, we shift focus towards how their investments fit their longer-term financial plan.  Your financial security doesn't stem solely from the valuation of your stock portfolio, don't emotionally tie yourself to that fact and focus on the other areas that are equally important:  do you have a job that provides current income to support your lifestyle?  do you have a home or a way to put a roof over your head? are you insured against non-market risks like death or incapacitation? do you have other assets whose value is not tied to equity markets? 

Corrections are tough to withstand and somehow just because you've been through it before doesn't mean that the one you're in takes any less effort to weather. We hope you'll find our steps soothing and that they give you something productive to focus on.  We look forward to chatting with you in person soon. 

Opinions expressed are that of the author and are not endorsed by the named broker dealer or its affiliates. All information herein has been prepared solely for informational purposes, and it is not an offer to buy or sell, or a solicitation of an offer to buy or sell any security or instrument or to participate in any particular trading strategy. The Standard & Poor's 500 (S&P 500) is an unmanaged group of securities considered to be representative of the stock market in general. It is not possible to invest directly in an index. No recommendation should be inferred from any information presented in this article.