As Canadian and US stock market indexes hit new highs this year, many investors began expressing anxiety about a possible ‘correction’. Financial media personalities have also been speculating about the timing of correction from these recent market highs – following a strong run over the past year.
Let’s put this into perspective. Would these same investors be equally concerned if their homes were hitting record highs? No, it is likely they would be celebrating and cheering the market higher. So what makes the stock markets and equity investing different from other asset classes? And how does the fact of new equity market highs affect investors ability to build wealth and retirement assets over time?
Markets have always moved up and down over short periods of time, and in fact they might have already corrected by a few percentage points by the time you read this. Such daily changes (referred to as “volatility”) are often mislabeled by investors as “loss”. Market volatility is completely normal and belies the fact that the long-term trend for corporate profits has generally been higher. Rising corporate profits are what ultimately drive individual equity prices higher over time.
The important point to remember is that while stock market values may decline over a short time frame they have historically recovered and seldom stay in the depths of a correction for very long. Investors can try to dampen volatility (so that they feel better about their portfolio) but doing so may also negatively affect their ability to generate investment income and growth.
What also affects views about record market levels is the type of correction are we talking about and what type of investor you are. For example, most market corrections (which are not the same thing as a permanent loss) happen within a strong and continuing business cycle expansion. Which means that market values may bounce around somewhat even as the economy continues to grow and recover from the previous recession. The other type of correction happens when the business cycle ends in a recession – which has been occurring roughly every 5 to 10 years since about 1990.
How does all this affect an average Canadian in their thirties with low savings relative to earned income? Market corrections are a great opportunity to buy quality investments on sale! For investors in their seventies cash flow and capital preservation are usually more important than growth. These investors need an asset allocation strategy to smooth out their cash flow in anticipation of the inevitable recessions that are a regular part of our economic system. Wise retirees never have to sell investments at market lows to pay for groceries.
Even if you are correct and can figure out when the next recession might start, will you then jump back into the investment markets to profit from the next upward business cycle? Behavioral finance suggests that very few individual investors are consistently successful at predicting and profiting from market corrections.
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