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After today’s 1,000-point, 4 percent hammering, most major stock market averages are either approaching — or are now officially in — correction territory, defined as a decline of 10 percent or more.
Feeling a little nervous?
While I’ve watched all of my 2018 gains evaporate in a matter of days, I’m still relatively sanguine. Anytime stocks go up in a straight line — and this market pretty much has — a pullback like this one is par for the course.
Typically, corrections aren’t as rapid and gut-wrenching as this one has been — you can thank computer trading for that. But when markets rise 30 percent in 14 months, a pullback isn’t only normal, it’s healthy.
While losing a sizable chuck of one’s net worth within a week isn’t anyone’s idea of fun, I’m nowhere near panic. My calm arises from three things: First, I’ve been investing in stocks for 40 years, so this is a block I’ve circled many times before.
Second, since I always keep some powder dry, soon I might be getting an opportunity to buy some stocks I failed to buy along the way. (Come down more, Amazon!)
Finally, I believe the economic underpinnings of the stock market are still strong. After all, with the exception of interest rates rising, not much has actually changed since stocks started selling off.
Below are the comments I made a few days ago. If you’ve already read them, you can stop here and rest assured I’ll keep you in the loop moving forward. If you didn’t, read on for questions and answers about what’s happening now and what you should be doing. Pay particular attention to “Should I buy? Should I sell?” The advice still applies.
Why is the market falling?
The market is falling for several reasons:
- It’s ahead of itself. Lately stocks have cost more than they should based on how much money companies are making. Historically, stocks have traded at prices of around 15 times their annual profits. So, if a company earned $1 per share in profits, their stock would be trading at $15/share. This is what’s known as a price/earnings ratio. Lately, however, stocks have been trading at about 18 times their earnings. So, historically speaking, they’re expensive. A falling market is making them cheaper.
- Interest rates are rising. As the economy improves, inflation, particularly in wages, is starting to show up. Rising wages lead to rising prices, which in turn leads to rising interest rates. Higher rates are great for savers, but bad for borrowers. Companies are typically borrowers. Rising rates cost them money, which pinches their profits. So, while stocks like healthy economies, they don’t like one of the byproducts of healthy economies, which is higher interest rates.
Where is it going next?
Possibly down more in the short term. But the economy is solid, so probably not too much more.
Should I buy? Should I sell?
It’s too early to buy, it’s too late to sell. There’s an old expression on Wall Street: “Don’t try to catch a falling knife.” The market is likely to be volatile for a while. Wait for it to settle down before getting in or getting out.
When will it be over?
Not to be overly simplistic, but it will be over when the sellers are gone and only buyers are left. This could be hours, or it could be weeks. If I had to guess, I’d say probably days.
Why didn’t you tell me?
I’m giving you simple answers to how we got here, and you’re probably hearing similar ones from many other sources. So, it’s natural to wonder why, if this stuff is so obvious, you’re only hearing about it after the fact and weren’t warned before.
Good question. The fact is that anyone who knows anything about the market knew it was overbought and knew it was due for a correction. The problem? Nobody knew exactly when to sell, just like nobody knows the exact right time to buy. Markets can be overvalued for weeks, months or even years.
Speaking of which: If someone tells you they knew exactly when to sell and will tell you exactly when to buy, they’re most likely either a liar or a fool. If there’s one thing I’ve learned over the last 30 years of market commentary, it’s not to take advice from either one.
In closing, remember that when times are tough, the tough make money. As legendary investor Warren Buffett put it: “Be fearful when others are greedy, and greedy when others are fearful.”
Does this market downturn have you panicked, or will you stay the course? Sound off by commenting below or on our Facebook page.