Share prices do not rise or fall in a straight-line. Instead, prices back and fill, take two steps forward and one step back or vice versa. Here are some lessons of past market declines.
Minor stock market fluctuations—five per cent or less, up or down—produce little comment or concern. Beyond that, especially on the downside, there begins a search for predictions on how far it can go.
Such predictions are easy to find, but not particularly reliable. In fact, there’s probably no greater uncertainty in investing than the questions, ‘Why are prices falling?’ and ‘How low can they go?’
Historically, every downtrend in the market has been followed eventually by recovery and a rise to new highs. The big question concerning recovery is ‘when’, not ‘if’. And, herein lies the ‘opportunity’ aspect of any market setback.
If prices are cheaper, ultimate appreciation potentials are greater when prices recover. So, whether you seek growth or income or both in the market, lower prices are usually an advantage.
Canadian stocks recently reached an all-time high and volatility has increased. Among the concerns nagging at investors are fears of new COVID variants, worries about potential increases in inflation and interest rates, speculative trading and high stock valuations. Consequently, many observers feel that markets are ripe for a setback.
If there is a setback, it will likely offer all the usual conundrums investors face in a pullback, and perhaps a few others as well. How far will the market fall? For how long? Why? Is it a market correction or a bear market? The answer, of course, is that no one will know for certain. However, that is not to say you’re powerless to assess and react.
Bear market versus market correction
A bear market, according to a standard rule of thumb, is any setback of 20 per cent or more. A market correction is usually defined as a setback of at least 10 per cent.
Last year’s setback in February and March, of course, was a bear market. From peak to trough, the S&P/TSX Composite Index dropped nearly 40 per cent. But it was a short-lived bear market, lasting just six weeks. This didn’t provide much time for the deliberate, long-term investor to react. But perhaps you might have been able to make a purchase or two at an attractive price at that time.
The bear market that occurred in the financial crisis of 2008 to 2009 was more long lasting. It took about nine months for the S&P/TSX Composite to lose nearly 50 per cent of its value. That period, plus the five subsequent years it took for the market to recover to its 2008 high provided plenty of opportunity to buy at lower prices.
Last summer and fall, the S&P/TSX declined just over eight per cent from August to October. Though not technically a correction, that period provided you some opportunities to buy at lower prices.
With respect to reactions in any market setback, the chief task will be to combat purely emotional responses, particularly on the part of those with existing stock portfolios. Discouragement, fear and perhaps even panic will loom from time to time. However, if you maintain the perspective of long-term investment goals, any downturn will seem less threatening. Naturally, investors will have to steel themselves to take advantage of the bargains that appear.
Nibble before you feast
Until a turnaround in the market is clear and evident, it will be a time for nibbling, rather than feasting, a time for spreading out commitments and emphasizing quality.
During downtrends, quiet times tend to be interrupted by hectic periods of selling. The hectic periods produce anomalies in share prices where stocks otherwise judged fairly equal are over-sold, producing sometimes significant differences in value. You should be on the lookout for advantageous trading opportunities here.
This is an edited version of an article that was originally published for subscribers in the March 5, 2021, issue of The Investment Reporter. You can profit from the award-winning advice subscribers receive regularly in The Investment Reporter.
The Investment Reporter, MPL Communications Inc.
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