We need to stop fearing corrections

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Market cycles are inevitable. We need to rewire our thinking about market corrections when approaching our investment portfolio. 

The days are counted until Christmas decorations start going up, year-end functions are in full swing, and we greet another interesting year. Oh, and what a year 2021 has been so far. Never a dull moment – ranging from the return of the Taliban in Afghanistan, multiple natural disasters and of course, the pandemic we have now been living with for around 18 months.

Looking back at 2021 so far in the markets, we have seen an excellent recovery (and not only viewed from the crash in March 2020).

At the time of writing, the year-to-date return for the FTSE/JSE All Share Index (ALSI) is at 11.4%, and the global markets MSCI ACWI in rands at 11.1%. The question of course is whether these returns will last, or if we have a correction looming? Especially on the global side.

And the answer is quite simple – yes, we do. We always have, and we always will experience this. And therefore, perhaps we need to rewire our thinking about these corrections when approaching our investment portfolio in principle.

Corrections (defined as a 10% decline in the market) are more common than we think – yet we tend to forget that when they happen.

The S&P 500 has experienced 38 corrections over the past 70 years. That means one decline of at least 10% happens every 18 months. In addition, there has been more significant movements in the market (20% or more), referred to as a crash to be less subtle. The markets have experienced six of these over the past 25 years.

Graph 1 indicates the market pullbacks of both the JSE as well as the S&P 500 over the past two and a half decades:

Graph 1: Market pullbacks on the JSE since 1996

Graph 2: Market pullbacks on the S&P500 since 1996

As we can see looking back, corrections and crashes happen often, and they happen fast. Market cycles are inevitable, and only hurt when losses are realised during one of these corrections. We need to realign our thinking again in these extreme times, to realise that the corrections will happen (most probably sooner rather than later, but they will also recover again) and sitting on your hands in these times will be the most important investment decision you will ever make.

Following a diversified approach softens the blow significantly when it comes to market corrections. Including cash and bond exposure in your portfolio will ensure that you have uncorrelated asset classes in your portfolio, not only protecting your portfolio’s average return over the longer term, but also providing liquidity if needed during a time of a correction. This allows the equity components in your portfolio the time needed to recover again. This way you won’t be incurring any real loss, and corrections don’t need to be feared, but rather embraced for the opportunities they hold – everyone loves a good bargain.

Elke Brink is a wealth advisor at PSG Wealth. 

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This article was written exclusively for finweek's 1 October newsletter. You can subscribe to the weekly newsletter here.

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