Sometimes, the capital markets can be unpredictable and chaotic. On March 28, 2024, the S&P 500 peaked, and since then, it has retreated by 5.3%, while the U.S. Aggregate Bond Index is down 2.6%. The only major asset class up since the market peak is Commodities and daily volatility has spiked up.

This downward turn has sparked fear among investors, causing many to question if this is merely a blip or a harbinger of more significant declines.

Investor sensitivity to market corrections has notably increased, often to the detriment of long-term financial goals. Most investors remember the 2008 Financial Crisis and will do anything to prevent that scenario from repeating.

However, this heightened sensitivity can lead investors to make precipitous decisions, driven by fear rather than fact. As emphasized in the quote by Howard Marks, emotions often drive investors to act exactly opposite to what might be beneficial — buying high and selling low.

It's essential for seasoned investors, especially those managing their retirement portfolios, to understand that market volatility is not merely an obstacle but a natural part of the investing landscape.

Understanding Market Corrections

A correction is typically defined as a decline of 5% to 10% in the value of an asset class or an individual holding from its most recent peak. These declines are usually short-lived but can provoke significant investor anxiety.

Unlike bear markets, which are marked by declines of 20% or more and can last for extended periods, corrections are often viewed as normal adjustments within a long-term market uptrend.

Historical Perspective on Market Corrections

Looking back over decades, market corrections are a common occurrence, yet they have not prevented the overall upward trajectory of major stock indices like the S&P 500.

Data from Fidelity Investments indicates that the S&P 500 has delivered positive returns over any 20-year rolling period from 1950 to 2021, with an average annualized return of around 10%, despite numerous corrections and bear markets during that time.

Statistical evidence supports the view that market corrections, while unsettling, are not uncommon and are often short-lived.

According to data from Hartford Funds, since 1980, there have been 37 corrections (declines of 10% or more) in the S&P 500 index, with an average duration of around 4 months.

Despite these frequent corrections, the S&P 500 has still delivered an average annual return of around 10% over the long term.

Are we even in a Correction?

The current pullback barely makes it into the correction category, but judging from the number of clients that have expressed concern we are approaching panic mode.

The reaction to this pullback illustrates the heightened sensitivity to losses plaguing investors. Such hypersensitivity to losses will not serve investors well.

Let’s take a look at what’s happened since the March 28 peak in the S&P 500:

• Every major asset class is down except Commodities and Cash.

• All equity asset classes are down with US Small Cap equities bearing the brunt of the correction. The Russell 2000 Index is down 8.2% since the market peak.

• The performance of bonds has been positively correlated to equities resulting in losses across the spectrum of fixed-income sectors.

• Interest rates are up this year. The 10-year Treasury is up 75 basis points with the bulk of the rise (41 bp) since the March 28 equity market high.

• Short-term rates proxied by the 3-month T-bill are only slightly up for the year. Keep in mind that the expectation at the beginning of the year was for at least 3 cuts to the Federal Funds rate.

• In terms of equity market volatility, we’ve seen a rise from very low VIX levels. The VIX is up 6.25 points from the beginning of the year with the bulk of the jump concentrated since the equity market highs. The VIX and stock market prices are negatively correlated.

• As of April 19, the fear of a market collapse seems to be out of proportion to the fundamentals. Yes, interest rates are up significantly especially relative to the beginning-of-the-year expectations, but corporate profits and the general economy remain robust.

Is it time to panic and lower the risk of your portfolio? 

My honest answer is that it’s probably too late to do anything major and doing so would harm you in the long run.

Tweaks here and there are fine, but major asset allocation moves are not warranted at the moment.

If you have some cash on the sidelines by all means invest it now. You’re getting a sale price but the offer will likely be over soon.

Don’t be a cowboy and buy indiscriminately. Only buy something that fits your portfolio needs and with a margin error should the correction deepen further.

Uncertainty, not fundamental issues are driving this market correction:

• Geopolitical conflicts - oil may spike and supply chains will get gummed up with the issues going on in the Middle East. We’ve been there before. There is already a risk premium for this type of uncertainty.

• Timing of monetary policy - the Fed will cut rates at some point but not before it is certain that inflation is trending closer to their 2% target. Be patient. Your investment strategy should not be fine-tuned to Fed policy.

Psychological Impacts of Market Volatility

Market corrections often ignite strong emotional reactions among investors, primarily fear and anxiety.

These emotions can cloud judgment, leading to decisions that may undermine long-term investment strategies.

The immediate response to sell during a downturn—driven by the instinct to avoid further loss—can result in missing out on the inevitable recoveries that follow.

If the current market environment is stressing you out here are some tips:

Don’t Do This: 

• Panic Selling: Reacting to short-term market dips by selling off investments can lock in losses and preclude participation in the recovery gains that often follow corrections. Sell for the right reasons, but don’t do it because of fear.

• Attempting to Time the Market: Predicting market bottoms and tops accurately is nearly impossible. Trying to get too cute often results in underperformance as a study by Dalbar has found. The average equity mutual fund investor has historically underperformed the S&P 500 due to poor buy and sell decisions.

• Overreact to News: Sensational news can lead to exaggerated emotional responses that do not always align with the underlying fundamentals of the market. Stop watching the talking heads on TV.

Do This Instead:

• Maintain Liquidity: Having access to cash during downturns can ease the stress of market volatility and prevent forced sell-offs. You may even buy into the panic. At current cash yields (4-5%) think of cash as a tactical weapon.

• Rebalance Strategically: Assess how far off your target mix you are and rebalance if necessary. Rebalancing is usually about managing risk but at this time you may also pick up a couple of nickels along the way.

• Emphasize Quality Investments: This may be the perfect time to start a position in a high-quality investment. It’s like buying that clothing item you’ve always wanted at a discount. Don’t buy junk. Buy something you are willing to live with for a long time so even if volatility hangs around you will still benefit in the long term.

One option always open to you is to not do anything at all.

Focus on bigger issues than a short-term blip on the radar.

With the S&P 500 down 5.3% and the US aggregate bond index down 2.6% since the March 28, 2024 peak, it's understandable that investors may be feeling some anxiety.

However, this level of volatility is well within the normal range for equity and bond markets, and the underlying causes appear to be temporary factors rather than fundamental economic issues.

Market corrections, though challenging, are an integral part of the investment landscape. They test investor resilience but also teach valuable lessons about the importance of maintaining a long-term perspective.

Minor market corrections, while unsettling, should not divert investors from their long-term financial goals. These episodes provide valuable lessons in emotional discipline and strategic planning.

The ability to maintain composure and stick to a predetermined investment plan during these times is what differentiates successful investors from those who see their strategies derailed by panic.

The Big Picture:

• Investors just emerged from one of the worst weeks since 2022.  All major asset classes were down for the week except for cash. The culprit - inflationary pressures and geopolitical concerns. These issues are not new but given how complacent investors have become it’s not surprising that we’ve experienced a pullback.

• The big losers last week were Real Estate investors. This sector offers real value but sentiment is terrible at the moment. Real Estate will likely stay in this negative state until the Fed cuts rates. It may be a while.

• Cash is King. Given the inverted yield curve, cash is not the drag it usually is on performance. Right now it is vastly more attractive than longer-dated bonds. Once the Fed decides to cut things will change but for now, cash is king.

• The strength of the US dollar keeps detracting from the performance of international investments. On a trade-weighted basis, the US dollar has appreciated close to 5% this year alone.

• The investment environment is now risk-neutral. It may feel like we’re in panic mode but the data we use to calculate our Risk Aversion Index (RAI) is not yet pointing that way. Volatility had been so low going into April that “normal” now feels bad. The volatility we’re currently seeing falls safely within historical norms.

• Investors have been woken up after months of low volatility in the markets. Capital markets are always in flux and a healthy respect for risk is a key element of a sound investment strategy. In recent months that respect was in question.

• Low volatility typically occurs when investors are in the midst of a bull run and that’s exactly the state we had been especially for US Large Cap stocks.

Economy:

• Not much to report here. The US economy keeps chugging along. The vast majority of market observers expected a recession in 2022. It did not happen and this year the economy while a bit weaker is still expected to grow by 2.7% (IMF estimate).

• The two biggest uncertainties in the short term relate to the rate of inflation and Federal Reserve policy. Both are intertwined. Inflation is proving to be more sticky than expected and monetary easing is thus on hold.

• Yields are rising because economic growth is robust. Sure, some sectors such as housing have suffered due to the rise in rates over the last couple of years, but most US companies have maintained their creditworthiness. Credit concerns are not part of this cycle. Credit spreads have tightened as recession fears have receded.

• Global economic growth is recovering. The IMF expects World GDP to grow by 3.2% with emerging markets outperforming developed countries. India is expected to be the standout performer growing at a 6.8% clip in 2024.

Equities:

• US equities took a beating last week with the S&P 500 down 3% while the Russell 2000 dropped 2.8%. Sentiment shifted quickly with the tech-heavy Nasdaq 100 losing 6% for the week.

• In a week where we saw interest rates rise we also saw interest-sensitive sectors such as Utilities and Financials do the best. Dividend yield approaches also rose to the occasion last week.

• Overall, value outperformed growth by a vast margin. The S&P 500 Value index was barely down 0.2% while its Growth counterpart dropped 5.3%. Year to date Growth is still outperforming by almost 3%.

• On the international front, the Japanese equity market got hammered last week. The Nikkei 225 Index was down 6.2%, and the broader TOPIX Index lost 4.8%. Further depreciation of the Yen (-0.8%) contributed to losses.

• Chinese equities rose after the economy expanded more than expected in the first quarter. The Shanghai Composite Index gained 1.52%.

Bonds:

• The Federal Reserve is not in a hurry to lower rates. Why would they? The economy is too strong and recessionary fears have all but disappeared.

• Inflationary expectations are rising as investors realize that the Fed can do little to improve supply imbalances caused by a sputtering global supply chain. On the demand front where the Fed has the most control, higher interest rates have done little to dent consumer spending.

• Long-maturity bonds are getting hammered as expectations of a rate cut have vanished at least in the near term. Shorter-maturity bonds and cash are preferred.

• Investors should not base their purchases of long-duration bonds on the likelihood of getting a one-time capital gain (from the lower rates). Bonds should be held for their income, not their potential for price appreciation.

Signal Versus Noise

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