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Market Correction Coming? Plan Ahead.

January 05, 2021
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Equity markets have had a huge run since their March 2020 lows. Despite rising headwinds, investor optimism remains elevated and a market correction is possible. Market corrections are a normal part of investing and can be used as an opportunity if investors are prepared and plan ahead. Please click the link below to read Cetera Investment Management's latest commentary.

  • Given strong 2020 market returns and rising headwinds, a market correction is possible.
  • Market corrections are a normal part of investing and can be used as an opportunity.
  • Being prepared before and during a market correction is very important.

When the overall economy is doing well, companies sell more goods and services, corporate earnings increase, and investors buy the shares of these companies. Unprecedented fiscal and monetary stimulus that supported a sharp economic recovery in the latter half of 2020 helps to explain the very strong investor sentiment that has powered the nearly 60 percent stock market rally off of the March 2020 lows. As markets rise and valuations expand, investor optimism may be pricing in perfection, increasing the likelihood of a market correction. As we note in our 2021 Market Outlook, we believe the economic recovery will remain uneven in the near-term. 

There are many indicators, in our opinion, that suggest a near-term market correction is possible. These include high overall stock market valuations, market sentiment that is too bullish (the S&P 500 currently trades about 15% above its 200-day moving average and the latest Investors Intelligence sentiment survey, a contrarian indicator, shows the widest spread between bulls and bears since Jan 2018), recent signs that economic data is starting to slow, increasing COVID-19-related restrictions, and uncertainty around vaccine distribution. Investors have been very optimistic since the last market correction (September 2020) and some of these concerns could easily reverse market sentiment.

While a market correction is possible, keep in mind that they are not as alarming as the name suggests. In general, a market correction is a stock market decline that is more than 10 percent from highs. Though we anticipate a possible correction, in the imminent future, we do not foresee another bear market where stocks fall 20 percent or more from their highs. Significant fiscal and monetary stimulus should offer near-term downside protection. A correction can turn into a bear market when investor worries increase and lead to a broader and deeper market selloff.

Historically, there are many reasons that have caused market corrections:
Earnings disappointment. When a company misses its earnings expectations or reduces its earnings projections, investors may be disappointed and could sell the shares of that company. If enough investors sell many companies, it becomes a correction.

Non-stock market factors. Like we have seen when our economy has shown signs of heading toward a recession, a non-market, or economic factor, could cause a correction. Using the earlier analogy, a downshift in expected economic growth could affect the ability of companies to sell
goods or services. If investors begin to anticipate weakening economic growth, they may sell shares in advance of the actual weak economy coming to fruition.

Momentum breaks down. Some investors tend to follow stock trading patterns and have identified trends that they feel indicate an impending correction. If enough feel that way, it can become a self-fulfilling prophecy. For example, we have seen that when the S&P 500 trades at
least 11% above its 200-day moving average, the index has had a correction or, at the minimum, traded sideways.

Profit-taking. There is an adage: “trees don’t grow to the sky.” Sometimes, a stock has performed so well that investors become concerned that future appreciation is priced in and they sell shares. This is classic profit-taking.

If a market correction does occur, some tips on what to do in a market correction are as follows:

Review your holdings.Look for new potential opportunities to buy equities. Stocks that may have been too expensive before, may be more attractively priced. Because a correction tends to hit the entire stock market, in some cases, you can upgrade your stocks to better quality ones.

Utilize active money managers.Active money managers tend to buy equities based on their research (as opposed to an index manager that buys all stocks at index weights). During a market correction or a volatile market, an active manager should be able to use their investment
resources to find better potential opportunities.

Take a deep breath. According to Ned Davis Research, a market correction occurs on average about every 167 trading days (about every eight months). Market corrections are a normal part of the stock market. They have happened in the past and they will be a part of the future. Consider this, according to J.P. Morgan Asset Management, the S&P 500 has been positive in 30 of the past 40 years but the average intra-year loss in this index is -13.8%. This suggests that the stock market is positively biased and market corrections are a normal part of the stock market. 

Market corrections are a normal part of investing and there are steps that you can take to possibly mitigate the negative effects. Even before a market correction, you should review your financial plan to make sure that you are not too aggressive or too conservative in your investment portfolio. The ability to maintain a long-term investment plan is most important and having a financial professional review your time horizon, risk tolerance, and liquidity needs is important.

This report is created by Cetera Investment Management LLC. For more insights and information from the team, follow @CeteraIM on Twitter.

About Cetera® Investment Management
Cetera Investment Management LLC is an SEC registered investment adviser owned by Cetera Financial Group®. Cetera Investment Management provides market perspectives, portfolio guidance, model management, and other investment advice to its affiliated broker-dealers, dually registered broker-dealers and registered investment advisers.

About Cetera Financial Group
“Cetera Financial Group” refers to the network of independent retail firms encompassing, among others, Cetera Advisors LLC, Cetera Advisor Networks LLC, Cetera Investment Services LLC (marketed as Cetera Financial Institutions or Cetera Investors), Cetera Financial Specialists LLC, and First Allied Securities, Inc. All firms are members FINRA / SIPC. Located at 200 N. Pacific Coast Highway, Suite 1200 El Segundo, CA 90245-5670

Disclosures
Individuals affiliated with Cetera firms are either Registered Representatives who offer only brokerage services and receive transaction-based compensation (commissions), Investment Adviser Representatives who offer only investment advisory services and receive fees based on assets, or both Registered Representatives and Investment Adviser Representatives, who can offer both types of services. The material contained in this document was authored by and is the property of Cetera Investment Management LLC. Cetera Investment Management provides investment management and advisory services to a number of programs sponsored by affiliated and non-affiliated registered investment advisers. Your registered representative or investment adviser representative is not registered with Cetera Investment Management and did not take part in the creation of this material. He or she may not be able to offer Cetera Investment Management portfolio management services. Nothing in this presentation should be construed as offering or disseminating specific investment, tax, or legal advice to any individual without the benefit of direct and specific consultation with an investment adviser representative authorized to offer Cetera Investment Management services. Information contained herein shall not constitute an offer or a solicitation of any services. Past performance is not a guarantee of future results. For more information about Cetera Investment Management, please reference the Cetera Investment Management LLC Form ADV disclosure brochure and the disclosure brochure for the registered investment adviser your adviser is registered with. Please consult with your adviser for his or her specific firm registrations and programs available. No independent analysis has been performed and the material should not be construed as investment advice. Investment decisions should not be based on this material since the information contained here is a singular update, and prudent investment decisions require the analysis of a much broader collection of facts and context. All information is believed to be from reliable sources; however, we make no representation as to its completeness or accuracy. The opinions expressed are as of the date published and may change without notice. Any forward-looking statements are based on assumptions, may not materialize, and are subject to revision. All economic and performance information is historical and not indicative of future results. The market indices discussed are not actively managed. Investors cannot directly invest in unmanaged indices. Please consult your financial advisor for more information. Additional risks are associated with international investing, such as currency fluctuations, political and economic instability, and differences in accounting standards.

A diversified portfolio does not assure a profit or protect against loss in a declining market. The S&P 500 is a capitalization-weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.

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