How We Deal With Market Corrections

By Yusuf Osman, MBA

If you’ve been paying attention to the news, you know the markets have endured a topsy-turvy start to the year. While the TSX has fared relatively well due to its overweight in Energy, the S&P 500, Dow Jones and Nasdaq are in what analysts call a market correction. (1) Should this volatility continue, you’re likely to see that term a lot in the days ahead.

Headlines proclaiming a market correction can often look very scary. That’s a problem because fear is every investor’s worst enemy. It’s what drives investors to make irrational and shortsighted decisions instead of sticking to a coherent strategy. So, in this message, I’m going to briefly cover some of the causes behind the current volatility before providing a refresher on our investment strategy.

What Is a Correction?

Quick refresher in case you’ve forgotten or are unfamiliar with the term: A market correction is defined as a decline of 10% or more from the most recent peak.

Corrections are fairly common. Prior to this month, we’ve had ten since the turn of the century alone…of which three turned into bear markets. (2) They’re also generally short-lived, lasting three-to-four months on average. (3) But they still need to be taken very seriously, as we’ll cover later in this message.

There are two main issues driving the markets into correction territory. The first is an old story, one we’ve been dealing with for over a year now. The second is newer, at least to those of us living on this side of the Atlantic.

I’m referring, of course, to inflation and Ukraine.

Inflation

Let’s start with inflation. As you know, the ongoing pandemic has wreaked havoc on global supply chains. This has caused prices to rise on everything from cars, to food, to toiletries. At the same time, the economy has expanded, partially due to the Fed keeping interest rates at historic lows. The result? Skyrocketing inflation.

Early in the recovery, the Fed hoped that inflation would be transitory, meaning temporary and short-lived. But inflation has proven stubbornly persistent. After all, COVID-19 has not gone away, choosing to spit out new variants instead.

For months, investors have been expecting the Fed to raise interest rates to combat inflation. (Higher interest rates slow the economy by encouraging consumers and businesses to save rather than borrow or spend. This, in turn, leads producers to lower prices to attract new business.) Now, in 2022, many analysts anticipate the Fed will raise interest rates several times this year. Which was confirmed at the Fed meeting near the end of January.

Why do investors fear the prospect of higher interest rates? Well, low interest rates mean that many securities, like bonds, simply don’t provide the same return on investment as they would in a high-interest-rate environment. That drives more into the stock market to get the returns they need. Higher interest rates could potentially reverse this trend, leading to money flowing out of the stock market and into other areas. When that happens, stock prices typically fall.

For these reasons, the interest rate/inflation story is unlikely to go away anytime soon. But now, the markets have a new question mark to deal with: Russia’s invasion of Ukraine.

Ukraine

Now, this is hardly the place to dive into the long and controversial history of Russian-Ukrainian relations. So, let’s just cover the basics. In recent weeks, Russia has moved over 100,000 troops near the Ukrainian border. (4) This has NATO to be understandably concerned. (Remember, Russia forcibly annexed Crimea from Ukraine back in 2014.) All the major nations in the region are currently engaged in diplomatic talks, but as we all know now, Russia has just launched an offensive into Ukraine.

Compared to inflation, it may be hard to see why this story has any effect on the markets at all. The reason can be boiled down to a single word: uncertainty. Let’s step back a few days. The issues affecting the markets have been: Will Russia really invade Ukraine? No one’s certain. What would happen if Russia did? No one’s certain. What will the US and other Western countries do about it? No one’s certain. If, theoretically, the US were to levy sanctions against Russia, or prevent Russian banks from doing business with the US financial system, what would that do to global trade? No one’s certain. The overarching theme has been uncertainty.

The markets hate uncertainty. When investors encounter it, they tend to draw the curtains, head for the hills, and circle the wagons. So, when you see a broad selloff after news like this, keep in mind that it’s not because investors know what will happen. It’s because they don’t.

Historically, geopolitical events tend to have a very short-lived effect on the markets. That’s because, as the situation clarifies and uncertainty is replaced by understanding, the markets will settle down and go back to focusing on more domestic concerns. Sadly, the outcome of this conflict, including the hardships that will be faced by the Ukrainian people, will have very little bearing on the market. (On a personal note, sometimes the conflict between my job and my personal humanity can be sorely tested!). As long as uncertainty is replaced with something more easily evaluated. I will keep a close eye on this. If the Russia-Ukraine crisis continues to impact the markets over the coming weeks, I will cover the subject in greater depth in a future message.

Our Strategy

The world just seems to be a bit on edge at the moment – Covid fatigue, trucker convoys, increasing prices on everything including energy, Ukraine, which creates an atmosphere of uncertainty. Uncertainty drives fear, and fear drives investors to make irrational decisions. The media often likes to portray short-sighted decisions as being solely about “selling instead of buying,” but we know from experience that the reverse can also be irrational. In fact, one of the worst mistakes investors can make is buying and holding regardless of market conditions, because they assume the markets will always go up over the long term. (Ignoring, of course, the time lost and hard work that’s required for your portfolio to recover.)

I find that, while corrections are common and often temporary, they can worsen into bear markets. Furthermore, any decline can have a significant impact on your portfolio, and by extension, your financial goals. So, while we don’t believe in panicking whenever a correction hits, neither do we believe in simply standing still. For this reason, our strategy calls for us to:

Analyze market trends instead of simply market headlines. Is a particular investment, asset class, or the market as a whole trending down? If so, what are the underlying causes? And most importantly, how is it likely to impact your money?
Follow our rules that determine at what point in a trend we decide to buy, and at what point we decide to sell. For example, if an investment gives us a sell signal, we follow “the rules” and sell. Period.
Be prepared at any time to “switch to defense” and move largely to cash to protect against losses and keep you from backsliding on the road to your financial goals.

We can agree that uncertainty abounds in the world and in the markets right now, and nobody knows with certainty what will happen next. We’re no exception. But unlike the average emotional investor, or average buy-and-hold investor, we don’t focus on that. Instead, we focus on how things are trending now. We then follow our rules.

And that is how we deal with market corrections.

Now, by the time you read this, it might already be too late to protect your portfolio from this decline (bear market, maybe?). But what about the next one? Shouldn’t you (we) start preparing now? I invite you to reach out to me to set a 15-minute phone call to discuss my Flex Investment Strategy. Then we let the chips fall where they may.

If you have any questions or concerns that I didn’t address in this message, please feel free to contact me. In the meantime, always remember that my team and I are here for you. From inflation to Ukraine and everything in between, we’ll keep monitoring the situation, so you don’t have to…and inform you immediately if there’s ever anything else you need to know. Contact me at (613) 447-1770 or yusuf.osman@gmii.ca.

About Yusuf

Yusuf Osman is a Financial Advisor at Global Maxfin Investments Inc., an independent full-service financial advisory firm dedicated to helping clients create financial freedom, security, and peace of mind. With over 30 years of experience in the finance industry, Yusuf is committed to educating, engaging, and inspiring as many people as possible to take control of their finances. He spends his days developing a thorough understanding of his clients’ lives, concerns, and dreams to help them build a financial plan that keeps pace with changes in both the markets and their lives. Yusuf graduated from the University of Ottawa with a bachelor’s degree in Science and earned an MBA in Finance from Queen’s University. To learn more about Yusuf and his Dynamic Wealth Program for Women, go to Dynamic Wealth Program for Women | Dynamic Wealth.

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(1) “Dow, S&P 500 and Nasdaq all in ‘correction’ territory as inflation and geopolitical tensions flare,” CBS News, January 24, 2022. https://www.cbsnews.com/news/stocks-s-p-500-dow-nasdaq-correction-inflation-russia-ukraine-2022-01-24/

(2)“What is a stock market correction?” The NY Times, January 24, 2022. https://www.nytimes.com/article/stock-market-correction.html

(3) “Correction,” Investopedia, updated January 24, 2022. https://www.investopedia.com/terms/c/correction.asp

(4) “How Russia’s Military is Positioned to Threaten Ukraine,” The NY Times, January 7, 2022. https://www.nytimes.com/interactive/2022/01/07/world/europe/ukraine-maps.html