Let’s face it - 2021 didn’t have much to love about it. But one thing I think we all enjoyed was seeing almost all our monthly investment statements showing improvement each month. Well --spoiler alert-- January of 2022 is starting out a bit differently.
For several months, we have been believing a correction was in the cards. However, each time we started down, optimism interrupted the process and the rally continued. This time the combination of inflation fears, interest rate hike fears from the Federal Reserve, a slowing economy from Omicron, and global tensions finally provided the push needed to correct.
As we discussed in last month’s newsletter, corrections are part of the investor experience and should be expected to occasionally visit – like a stomach bug or jury summons. They are unpleasant and disruptive but part of life. For the most part, normal corrections need to be addressed ahead of time with prudent allocation decisions. Panic and knee-jerk reactions rarely improve the situation.
So why do corrections start and when do they end? The best place to start this discussion is with a clear understanding of what the stock market is. First and foremost, it is a market. It is a place where people gather to buy and sell. And as you have likely noticed in all other markets – the bigger the market the more confidence you have that the price you are paying is fair. Have you ever “priced checked” something on Amazon to make sure the price elsewhere was reasonable? More competition typically delivers better pricing.
The price of a stock is constantly being determined by buyers and sellers trying to work out how the latest information changes the value of an investment now and in the future. When the information is good – the price often goes up. But when enough cracks appear in the story bringing into question our “glass half-full” price assumptions – group sentiment can change quickly and now we can only see the negatives. Corrections happen when the majority of buyers and seller suddenly change their mind on the future.
This rapid change in sentiment is what causes the quick and sometimes stomach-churning changes in the price and value of investments. This selling-off process typically continues until enough buyers find the new lower price too good to pass up. This process of “putting in a bottom” to a correction is often murky and uncomfortable. But it is also the place to find the best bargains.
If this sounds chaotic, it is. But it is how a free market does and should work. It is the best way to know that your investments are being priced fairly. Putting up with the occasional chaos (volatility) is why investors often make significantly more than savers over time.
The good news is that some of this volatility can be managed. We do this by mixing in assets that typically don’t do down as much during declines and managing your cash flow needs so we don’t need to sell when markets are down. Often the best remedies for a correction are preparation and time.
If there is anything we can do to help you stomach the current volatility – Let us know!