As you have likely heard, the Dow Jones Industrial Average has declined 10% from its peak several months ago. The media calls this a “correction.”
It is customary, and often appropriate, for financial advisors to tell their clients not to worry about such developments. But some people will worry no matter what their advisor says. And there are some people who should worry about such a development, but who won’t.
Here are some reasons it may be appropriate for you to interpret recent market turbulence as a call to action:
If you are not aware that it is very common for stocks to drop 10% or more. The S&P 500 index of the 500 largest U.S. publicly-traded stocks has declined more than one out of every four calendar years over the past century. Indeed, the market has dropped more than 10% during 19 out the last 35 years since 1980, and in the majority of occasions, bounced back within a few months. In addition, 70% of the time after a week in which the S&P 500 dropped more than 5%, that index was higher twelve weeks later than before the drop.
If you think that what happened last week, month, or year, is predictive of what will happen next week, month, or year, in spite of the fact that research clearly demonstrates that in the short term the market moves in ways that are impossible to predict -- even the smartest computers on Wall Street have not been able to predict sell-offs reliably.
If you have not observed the technological, political, demographic, and economic forces that have halved the global poverty rate and created millions of middle class households in Asia, Latin America, and Africa over the past 20 years, or you think these forces are going away.
If you suffer psychologically when the stocks in your portfolio have dropped 10%, or when you contemplate that they could drop way more than that in the future, like they did during the Great Recession and dot.com bubble when stocks dropped over 50%.
If you will or might need money you have invested in stocks to handle your cash flow needs over the next several years (e.g., down payment on a house, college for your child, or retirement living expenses), or you have not thoroughly diversified your stock holdings.
Whether or not one of the items listed above applies to you, you might find the attached article from the World Economic Forum
of interest. It suggests that even if the stock market drops further from here, it is not likely to lead to the kind of disruption we have seen during the last two market downturns.
In short, the article outlines four different kinds of asset bubbles, relying on research from the Federal Reserve Bank of San Francisco, which studied nearly 150 years of corrections and bear markets all over the world. The essay cites evidence that when corrections are triggered by stock market growth of the sort we have seen over the past several years, such declines are not particularly threatening, and likely to rebound relatively quickly. Of greater threat are increases in stock prices that are driven by lots of borrowing (not the case now), by rapidly escalating housing values (not the case now), or the worst of all, by both heavy borrowing and skyrocketing housing values.
So for now, if none of the five items above applies to you, you might as well ignore the drama that media will whip up in response to the recent decline in stock market values. Otherwise, allow the drama to trigger a mood of prudent concern that will help you think and act more effectively with your investments.