For many first-time investors, the stock market can be a scary place. When the markets take a downturn, it can be even more intimidating! Investing isn’t always easy, and anyone who says otherwise, isn’t telling the whole story. The truth is that there will be times when the market takes a turn for the worse, and your portfolio values suffer as a result. The most common downturn is often referred to as a market correction.
A market correction is when you see a decline in the market, from peak values, of 10 to 20%. From a historic perspective, corrections are relatively common and occur about once per year on average. There have been 19 stock market corrections in the last 40 years, and they usually last no more than two or three months.
In 2018 and 2020, the TSX in Canada and the S&P 500 in the US both saw sizable corrections. In 2018, the intra-year lows for these markets were approximately -17% and -20%, respectively. In 2020, they were approximately -37% and -34%, respectively). However, the markets in both of these cases later experienced a major improvement (Kassam & Zhou, 2022).
The first correction in 2018 was caused by a few things. The main reason was the trade war with China. This created uncertainty in the market and caused investors to sell stocks. Another reason was that interest rates were rising, which made stocks less attractive compared to other investments like bonds.
The 2020 correction was caused by the coronavirus pandemic. The virus caused many businesses to close and led to job losses, which decreased the demand for goods and services. This, in turn, led to a decrease in stock prices. The Canadian markets were especially hard-hit by the pandemic, as the country is highly dependent on trade.
As of July 25th, 2022, all the major markets are down more than 10% from their previous highs, and this means the stock market is in a correction. It isn’t just equities that are having a hard time. We are also seeing bond prices go down; gold and silver prices have also fallen sharply. The reason for the sharp decline in stock prices is the rise in interest rates. When interest rates rise, bond prices fall, and when bond prices fall, stock prices usually follow. The reason for the decline in gold and silver prices is the stronger dollar. Gold and silver are priced in US dollars, so when the dollar goes up, gold and silver prices usually go down.
While there are many factors that can lead to a market correction, two of the key reasons behind the current slump are high inflation and increasing interest rates. Inflation refers to the overall price level of goods and services in an economy, and it can have a harmful impact on both consumers and businesses. When prices rise too quickly, consumers may be unable to keep up with the cost of living, and businesses may find it difficult to invest and expand. This has been compounded by the Bank of Canada and the Federal Reserve’s decision to raise interest rates, which has made borrowing more expensive and further reduced consumers’ ability to spend. As a result, businesses have been forced to scale back production, leading to layoffs and an increase in unemployment.
Now that we know what has happened, what can we do about it? The following tips will help you navigate a market correction:
- Don’t panic! It’s normal for the markets to go up and down, and corrections are actually a healthy part of the market cycle.
- Remember that corrections are usually short-term. They may be painful in the moment, but they don’t last forever.
- Review your investment goals and objectives. This will help you determine if you need to make any changes to your portfolio.
- Stay disciplined. It can be tempting to sell everything during a market correction, but it’s important to stay disciplined and stick to your plan.
While stock market corrections can be painful in the short term, they are necessary for long-term market health. Corrections help to remove weak hands from the market and reset valuations to more realistic levels. Without corrections, stocks would become increasingly overvalued and eventually bubble. While it is unpleasant to watch your portfolio value decline, remember that corrections are a natural and healthy part of the market cycle. Over time, the market has always recovered from corrections and gone on to new highs. So, while a correction may be painful in the short term, don’t let it dissuade you from investing for the long haul.
