October 2017 Monthly Insight: Thoughts on a Potential Market Correction

Posted By T. Lee Sherbakoff, CPA/PFS, CFP® on Oct 4, 2017


“I can calculate the movement of the stars, but not the madness of men.” –Sir Isaac Newton

The Wright brothers successfully conducted the first manned flight at Kill Devil Hills, NC, on December 17, 1903. However, an aircraft’s movement through the air can be explained and described by physical principals discovered over 300 years ago by Sir Isaac Newton. He developed his theories of gravitation in 1666, when he was only 23 years old. Twenty years later, he presented his three laws of motion in the “Philosophiae Naturalis Principia Mathematica.” These revolutionary discoveries explain the relationship between a given body and the forces acting on it, and changes in the body’s motion in response to those forces.

However, as brilliant as Newton was as a mathematician, physicist, and theoretician, he, like millions of investors who came after him, could not time the market. Newton’s experience is like so many others.  As the story goes, he invested a small amount of money in the South Sea Company (the hottest stock in England at the time); watched the returns accumulate quickly; and immediately sold for a small, quick profit. He exited the market happy, but then saw his friends get richer and richer as he heard their boastful stories. So, he jumped back in the market near the peak and invested a lot more money—some of it borrowed. Caught in the decline, he was totally wiped out as the market fell below where he had made his early, small investment. Thus, he lost it all.

Warren Buffett in his 2005 Berkshire Hathaway Shareholder letter said, “…Sir Isaac’s talents didn’t extend to investing: He lost a bundle in the South Sea Bubble, explaining later, ‘I can calculate the movement of the stars, but not the madness of men.’ If he had not been traumatized by the loss, Sir Isaac might well have gone on to discover the Fourth Law of Motion: For investors as a whole, returns decrease as motion increases.

Historically, bear markets have occurred twice each decade. A bear market is a drop from peak to trough of over 20%. Our last bear market ran from October 2007 to March 2009 and the market dropped over 57%. Since that time, the market has been on one of its longest up-market runs ever. Through September, the current bull market is up 272% and has run 102 months, the second longest run since 1926. The run-up was punctuated last Friday as the market (S&P 500) set a new all-time high, closing at 2,519.44.

So, surely the market is due for a correction (a drop of 10%) or perhaps dipping into bear territory by dropping over 20%. Well, the fact of the matter is no one knows. We don’t know when it will happen, we don’t know what will trigger it, and we don’t know how far down it will go. The only thing we can be sure of is that we are going to see another downturn….sometime. Expansions and contractions are a natural part of our economy and bull and bear markets are a natural part of investing.

Our question to you is: Are you prepared for another market decline? If the market goes down 20%, 30%, 40%, or even 50%, can you ride it out for five years?  We say five years because we’ve only recently gone through the worst economy since the Great Depression. The banking system in this country failed. The only reason is didn’t collapse is that the government bailed out the banks. And yes, the market bounced back after only five years. But here we are, eight years later, and once again we’re at all-time highs. So while we certainly hope we won’t see down markets of that magnitude again, we can’t guarantee we won’t.

If you cannot sustain market losses on paper and ride them out for five years, we’d like to again offer to you the opportunity to come in for a consultation. We will review your goals, objectives, and financial plan. The goal would be to plan now so that you can sleep peacefully at night, if and when the market goes down significantly.

We can never discount unexpected volatility. But as we’ve previously said, the investment plan we’ve recommended for you takes unexpected turbulence and volatility into account. That’s why your portfolio is diversified across assets and sectors. Remember, timing the ups and downs in stocks is rarely profitable longer term. In reality, it only delays the day you reach your financial goals.

We hope you’ve found this review to be educational. Let us emphasize again that it is our job to assist you! If you have any questions or would like to discuss any matters, please feel free to give us a call.  As always, we’re honored and humbled that you have given us the opportunity to serve as your financial advisor.