When markets take a sudden dive, it’s easy to feel a wave of panic, especially when you’re managing your own portfolio.

However not all market corrections are created equal. Some are driven by deep-rooted economic issues, while others are simply the result of short-term shifts in sentiment. The challenge for retirees and investors alike is distinguishing between the two.

This is where the principle of "Trust But Verify" comes into play.

It’s a strategy that encourages you to remain confident in your long-term plan while also taking the time to understand the underlying causes of a market correction.

Is the drop in your portfolio’s value a sign of fundamental weakness, or is it merely a reaction to temporary market fears?

By carefully analyzing the situation, you can make informed decisions that align with your retirement goals, rather than reacting impulsively to market noise.

The Psychology of Market Corrections: Sentiment vs. Fundamentals

Market corrections can be unsettling, particularly when you’re managing your own retirement portfolio.

These downturns, usually defined as a decline of 10% or more in a major stock index, often spark fears of more severe losses. But not all corrections are created equal. Understanding the psychology behind them is crucial to making informed decisions.

Sentiment-Driven Corrections

Sentiment-driven corrections are often the result of emotional reactions rather than changes in a company’s financial health or the broader economy.

These corrections can occur when investors collectively panic due to a perceived threat, such as geopolitical tensions, changes in government policies, or even rumors and speculation. The market, in such cases, responds not to concrete data but to fear, uncertainty, and herd behavior.

For example, during the 1987 stock market crash, commonly known as "Black Monday," the S&P 500 plunged 22% in a single day. Despite the dramatic drop, there was no significant change in the fundamentals of the U.S. economy or the companies within the index.

Instead, it was a sentiment-driven event, fueled by panic selling and a lack of confidence in the market’s stability.

Investors who sold in a rush of fear likely locked in losses, while those who remained calm and assessed the situation may have recovered their losses in the months that followed. The S&P 500 finished in positive territory in 1987.

Fundamental Corrections

On the other hand, fundamental corrections are rooted in tangible economic factors.

These corrections occur when the market adjusts to new information that indicates a slowdown in economic growth, declining corporate profitability, or an overvaluation of assets.

For instance, the 2008 financial crisis was a fundamental correction driven by a collapse in the housing market, widespread defaults on subprime mortgages, and a subsequent banking crisis.

In this case, the correction was justified by severe underlying economic issues, and the market's downturn reflected the reality of those problems.

Why Understanding the Difference Matters

For investors managing their own investments, distinguishing between sentiment and fundamental corrections is essential.

Reacting to a sentiment-driven correction by selling assets could mean missing out on the inevitable rebound once the panic subsides. Conversely, ignoring a fundamental correction could lead to more significant losses if the underlying economic issues continue to deteriorate.

This is why the "Trust But Verify" approach is so vital.

Trust your long-term plan and the strategies you’ve put in place, but verify the reasons behind market movements before making any decisions.

By doing so, you can avoid knee-jerk reactions and make informed choices that support your financial goals in retirement.

The Current Situation:

The peak of the S&P 500 occurred on July 16. While the equity market has recovered and volatility has dropped the S&P 500 is still 4% below the peak value. Small caps are down almost 8% since the peak.

The good news for diversified investors is that not only have equity markets recovered most of their losses but bond markets have had positive returns.

In terms of economic sectors, the correction has hit growth investors much harder than value investors. The Russell 3000 Growth Index is down 6.1% from the peak while the Value Index is down only 2.3%.

Technology and Consumer Discretionary stocks have borne the brunt of the correction. Among S&P 500 stocks both sectors are still down over 8% since the index peak of July 16. In contrast, typical value sectors such as Utilities, Staples, and Real Estate have shown positive returns since July 16.

According to our Technical Stage Indicator analysis, the “correction” has been less about the whole market as opposed to a rotation away from growth toward value.

It’s felt like a correction because of the massive jump in volatility and the capitalization weighting structure of the S&P 500 which at the moment is still dominated by large Technology companies.

The only two non-techie names in the top 10 of the S&P 500 are Eli Lilly and Berkshire Hathaway.

On an equal-weighted basis i.e. not taking the size of the company into account, the US market shows a preponderance of stocks in an upward, bullish phase. This is the technical picture as of last Friday's closing prices for our 3000+stock universe.

Trust But Verify: Analyzing a Correction

When faced with a market correction, the immediate instinct might be to make quick adjustments to your portfolio. However, it’s crucial to pause and analyze the situation thoroughly before making any decisions. This is where the principle of "Trust But Verify" becomes invaluable.

Step 1: Trust Your Long-Term Plan

First, remind yourself of the long-term goals you've set for your retirement.

Whether your strategy is focused on growth, income, or capital preservation, it’s essential to trust that your plan was built with these objectives in mind.

Corrections, especially those driven by sentiment, are often temporary and should not derail a well-constructed retirement plan.

Step 2: Verify the Underlying Causes

Next, it’s time to verify what’s causing the market correction. Start by examining key indicators:

Company Earnings Reports: Look for any trends in corporate earnings. Are they declining across the board, or is the correction isolated to specific sectors? Broad declines in earnings could signal a fundamental issue, while isolated drops may point to sector-specific problems.

Revenue for the S&P 500 rose 5.2%, the largest year-over-year growth since Q4 2022. According to Factset, this growth rate is below the 5-year average revenue growth rate of 6.7% but above the 10-year average revenue growth rate of 5.1%.

In terms of earnings, the year-over-year rate of growth for S&P 500 companies stands at 10.9%. For 2025, analysts are projecting earnings growth of 14.8% and revenue growth of 6.0%.

Current Assessment: Q2 earnings season results were robust. Looking forward to 2025 the outlook for earnings is positive. No concerns at the index level.

Economic Data: Check the latest economic reports. Are there signs of an impending recession, such as a slowdown in GDP growth, rising unemployment, or declining consumer confidence? These factors can help determine if the correction is justified by economic fundamentals.

Goldman puts the odds of a recession in 2025 at 41%, JP Morgan at 31%. Clearly, we are in the late innings of a recovery from the mini-recession of COVID-19 but growth still seems robust.

Recession indicators do not have a good predictive record. In 2023 the consensus was for a recession but nothing happened.

It’s too early to tell if a recession in the US is imminent.

Current Assessment: Stable, robust growth. Normal for this stage of the business cycle with interest cuts on the horizon providing a boost.

Valuation Metrics: Review the valuation metrics like the Price-to-Earnings (P/E) ratio. If the market was previously overvalued, a correction might be a necessary adjustment. On the other hand, if valuations are within a normal range, the correction might be sentiment-driven.

The P/E on the S&P 500 is currently 27 compared to a historical mean of 16. High but not outrageous in light of where real interest rates stand.

Current Assessment: Stretched, but not bubble-like

Step 3: Be Patient and Avoid Impulsive Decisions

Once you’ve gathered the data, take the time to assess it before making any changes.

Impulsive decisions, particularly during a sentiment-driven correction, can lead to locking in losses that could have been avoided with a more measured approach.

Remember, you can’t compete with algo traders. You are never going to be able to have an edge playing the short-term game. Your edge is your patience and ability to manage your emotions constructively.

Step 4: Reassess and Adjust If Necessary

If your analysis suggests that the correction is driven by fundamentals and these issues are likely to persist, it may be time to reassess your portfolio.

Consider reallocating assets, reducing exposure to vulnerable sectors, or increasing your holdings in defensive investments.

If the correction is sentiment-driven (as we believe at the moment), it may be best to stay the course and avoid making significant changes.

By following this "Trust But Verify" process, you can make more informed decisions that align with your long-term retirement goals, rather than reacting impulsively to short-term market fluctuations.

Real-World Examples: Sentiment vs. Fundamental Corrections

Understanding how sentiment-driven and fundamental corrections have played out in the past can offer valuable lessons for today’s investors. Let’s look at a few notable examples and analyze how the "Trust But Verify" approach could have been applied.

Example 1: The 1987 Market Crash (Sentiment-Driven Correction)

On October 19, 1987, the stock market experienced its largest single-day percentage drop in history, with the Dow Jones Industrial Average plunging by 22.6%. This event, known as "Black Monday," was largely driven by panic selling and computerized trading strategies that exacerbated the decline.

Despite the severity of the drop, there were no significant changes in the underlying economic fundamentals. The U.S. economy was still growing, inflation was under control, and corporate earnings were stable.

Trust But Verify Application:

Investors who panicked and sold during the crash likely locked in significant losses. However, those who took a "Trust But Verify" approach—trusting their long-term investment strategy while verifying the absence of fundamental economic issues—may have recognized the event as sentiment-driven.

By staying invested, these investors would have seen their portfolios recover over the following months, as the market rebounded strongly in 1988.

Example 2: The Dot-Com Bubble Burst (Fundamental Correction)

The late 1990s saw a massive surge in technology stocks, fueled by investor enthusiasm for the internet’s potential.

However, by 2000, it became clear that many of these companies were overvalued, with weak business models and no path to profitability.

When the bubble burst, the NASDAQ Composite index, heavily weighted with tech stocks, lost nearly 78% of its value from peak to trough.

Trust But Verify Application:

In this case, a "Trust But Verify" approach would involve trusting in the value of long-term investing but verifying whether the valuations of these tech companies were justified.

Careful analysis would have revealed that many of these companies were trading at unsustainable multiples. Investors who recognized this could have reduced their exposure to overvalued tech stocks before the crash, thereby mitigating their losses.

Example 3: The 2008 Financial Crisis (Fundamental Correction)

The 2008 financial crisis was one of the most severe market downturns in history, driven by the collapse of the housing market and the subsequent banking crisis.

Unlike the 1987 crash, this correction was deeply rooted in economic fundamentals. The crisis led to a global recession, and it took years for the markets to fully recover.

Trust But Verify Application:

During the 2008 crisis, verifying the situation would have revealed significant weaknesses in the financial system and the broader economy.

Investors who adjusted their portfolios in response to these fundamental issues—by moving into safer assets such as bonds or reducing exposure to financial stocks—may have protected their portfolios from the worst of the downturn.

Lesson for Investors

These examples highlight the importance of understanding the underlying causes of market corrections.

While sentiment-driven corrections often present opportunities for long-term investors to stay the course or even buy at lower prices, fundamental corrections require a more cautious approach.

By applying "Trust But Verify," you can better navigate these challenging periods, making decisions based on data and analysis rather than emotion.

Applying 'Trust But Verify' to Your Retirement Portfolio

As a retiree managing your own investments, the stakes are high. You’ve worked hard to build your wealth, and protecting it during market corrections is crucial.

The "Trust But Verify" approach can be an effective strategy to help you navigate these uncertain times while staying aligned with your long-term goals.

Trust Your Plan, But Verify the Market Conditions

The first step is to have faith in the retirement plan you’ve crafted. Whether your focus is on growth, income, or preserving capital, it’s essential to trust that your strategy was designed to weather market volatility.

However, trust doesn’t mean turning a blind eye to changing market conditions. Regularly verifying the current economic landscape and market indicators will help you understand if your portfolio needs adjustments.

Diversify and Rebalance: Your First Line of Defense

Diversification is one of the most effective ways to manage risk, especially during corrections.

By spreading your investments across various asset classes—such as stocks, bonds, real estate, and cash—you reduce the impact of a downturn in any single sector.

Additionally, regular rebalancing ensures that your portfolio remains aligned with your risk tolerance and investment goals, especially after a correction has shifted your asset allocation.

Stay Informed, But Avoid Information Overload

Staying informed is critical to the "Verify" part of the strategy.

Keeping up with market news, economic reports, and company earnings can provide valuable insights into whether a correction is sentiment-driven or based on fundamental issues.

However, be cautious about information overload. The 24/7 news cycle can often amplify fears and lead to hasty decisions. Focus on credible sources and objective data rather than sensational headlines.

Consider Defensive Strategies When Necessary

If your analysis suggests that a correction is rooted in fundamental issues, it may be time to adopt a more defensive strategy.

This could involve increasing your allocation to bonds or other fixed-income securities, which tend to be less volatile during economic downturns.

Alternatively, you might consider reducing exposure to sectors that are particularly vulnerable to the issues at hand, such as financial stocks during a banking crisis.

Keep Your Long-Term Vision in Focus

Finally, always keep your long-term vision in mind.

Retirement is a journey, not a sprint, and market corrections are a normal part of the investment landscape.

While short-term losses can be unsettling, it’s important to remember that markets have historically recovered from downturns.

By staying focused on your long-term goals, you’re more likely to make decisions that benefit your financial future rather than reacting to temporary market fluctuations.

Asset Allocation Performance Review

High-Level Observations:

• All asset allocation portfolios we monitor are up year-to-date with higher-risk portfolios exhibiting commensurate higher returns.

• Conservative portfolios with a heavier allocation to bonds are still recovering from the rise in interest rates starting in 2022.

• Over the last three years, the GF Low-Risk strategy is only up 1.2% on an annualized basis (before fees and transaction costs). Going back 5 years the annualized performance improves to 5%.

• Equity-heavy allocations have outperformed more conservative allocations thanks largely to the performance of US large-cap equities.

• The GF High-Risk strategy is up 2.7% on an annualized pre-cost basis over the last three years. Over the last 5 years, the strategy is up a respectable 8.3%.

• Over the last month, Real Estate has performed best in large part driven by the expectation of lower interest rates and depressed valuation levels.

• Fixed-income strategies focused on short maturities and credit have outperformed Treasuries, but the gap has narrowed due to slightly wider corporate spreads and longer maturity rates coming down.

Weekly Performance Attribution

Long-Term Asset Allocation Portfolio Characteristics

Expected Returns: Expect slightly lower than normal equity and bond market returns given valuation conditions

Risk: Diversify with alternative assets, market volatility has been significantly below historical measures

Equity Risk: Asset allocation portfolios are dominated by equity market risk, no different from the past.

A Bit of Humor Never Hurts

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