Market corrections are downward adjustments in stock market values of between 10-20%.
The last market correction occurred from April—October 2011 in response to the European debt crisis, which spread from Spain, Portugal and Greece to the rest of the European Union. During the same time period, the rating agency Standard and Poors famously downgraded US debt for the first time ever from AAA to AA+ because of Congress’s late decision to raise the debt ceiling. In the ensuing months, the stock market lost 19.4% of its value. Since then, the United States has enjoyed a bull run (market going up) of approximately 1050 days. With market corrections happening every 18 months on average, currents markets are overdue for one.
Asking someone to predict the exact day a market will begin the downturn is an impossible task. However, there are warning signs investors use to predict its impending arrival and adjust appropriately. One has to be in tune with all the economic, political and social events occurring as they all have an impact on the stock market. Accurately predicting stock market directions based on these factors once does not guarantee success in future attempts—the reasons for a market correction will be different each time. I will discuss some factors that might cause it market adjustments this year.
The first factor concerns the pricing of the market itself. In contrast to individual stocks that I analyze through the lens of fundamental (quantitative factors such as earnings) and technical analysis (market movements and behavior), the broad market is predominantly at the mercy of mass behavior and thus must be assessed with technical analysis. From the bottom of the recession in 2009, the Dow Jones Industrial Average has rallied from 6,600 to 17,266—a 261% increase. From the record high point from before the recession it has increased an absurd 124%. Every day the market goes up now it sets a new all time record. In technical analysis, all time highs for investments are called resistance levels and all time lows are called floors. Whenever an asset reaches its resistance level it tends to drop and vice versa for its floor. In the case of the broad market, it has reached its resistance level therefore it is expected to trend downwards in the coming months.
The Pressure of Politics
We also have to consider several political reasons that can bring about a market correction.
The impending midterm elections in November play a large part in market expectations. It is expected that the Republicans will win the Senate for the next two years of President Obama’s term. If that happens then Congress will send bills to the President. As the two parties are likely to differ in their strategy to secure legislation, the losers of this gridlock and volatility will be the stock market. Internationally, the world is facing increased violence in Syria and Iraq. US Defense Secretary Chuck Hagel is planning to send troops and other resources to Syria to combat the ISIS threat. All the spending committed to this end will be a major draw on the nation’s resources. The budget surplus that the United States built up during the mid-1990s was whittled away by the two wars that President Bush started in 2001. It is bad enough that the administration is considering any involvement at all in Syria.
If it turns into a full blown war it could have a severe impact on the recovering economy.
Even though the market could go down, there are many investment opportunities to be exploited. With proper discipline and small adjustments, one can navigate the up and down cycles of the market. In a well-diversified portfolio, assets are organized between different asset classes in stocks, bonds, commodities and other assets. In a bull market, most common asset classes tend to rise with market. To avoid the opposite effect in a downturn, one must readjust the portfolio towards assets that are “safe.” For the inexperienced investor, it is best to put your money in defensive stocks—stocks which are less or completely unaffected by the market going down. Examples of defensive stocks include industry leaders such as IBM, Microsoft or Coca-Cola that largely move due to business reasons rather than broad market effects. For the more advanced investors one can move money from cyclical (moving with the market) to counter-cyclical stocks. One can also hedge (managing offsetting effects) the portfolio with assets that benefit from the market doing badly such as the volatility index (captures the increased volatility of market downturns) or assets that move in the opposite direction such as gold.
As human beings we are inherently optimistic about the world around us. However, as rational investors we should recognize markets for what they are—constantly moving up and down. Markets are a dynamic and complicated set of systems acted upon by external economic, social and political events. Understanding how these external events will impact investor behavior is the first step to deciphering which way the market is headed.
This article is the opinion of the author and is not shared by India Currents or any of its staff. All investors should conduct their independent analysis before taking any actions and should not make any decisions on the information provided in this article alone.
Rahul Varshneya graduated from the Leavey School of Business at Santa Clara University with a degree in finance and is working in the technology industry as a financial analyst. If you have feedback or have a topic you would like addressed please contact Rahul at firstname.lastname@example.org.