U.S. stocks are off to a rocky start in 2014, with the Dow Industrials down close to 7% so far, and the S&P 500 off about 5%. How unusual is this drop? The short answer: not at all. Corrections of this magnitude are quite common, especially after the run-up of 2013.
Note that even during the bull run we experienced last year, the Dow rode through two corrections: a drop of 5.3% last August and another 5.7% drop in Sept./Oct.
To put things in perspective, I took a look at the frequency of corrections in the Dow Jones Industrial Average from 1900 through 2013. During the past 113 years, the Dow has — on average — experienced:
- Drops of 5% or more, three times a year.
- Drops of 10% or more, once a year.
- Drops of 15% or more, every two years.
- Drops of 20% or more, every 3.5 years.
So corrections are the norm and actually a sign that the marketplace is doing its job – adjusting pricing to reflect changes in perceived value. So far, the U.S. equity markets have rebounded from every previous correction, albeit over varying lengths of time.
Beware of Getting Whipsawed
Although corrections are common and to be expected, no one really knows when they’ll begin or end. Take 2010, for example. That year, the Dow gained 9%, fell 16%, and went on to rebound 22% to finish the year up a very respectable 14.1%.
In a year’s time, the equity markets can be all over the chart – up, down, sideways – in jagged peaks and shadowed valleys. Some analysts have a field day trying to predict such short-term moves, but this is not our aim. We’re decidedly long-term investors.
As long-term investors, we don’t change our equity allocations based on emotional reactions to the market. We know that by sticking to our long-term equity allocations, we’re much more likely to benefit from a rebound in prices.
Say you reduce your stock exposure today because of market turmoil. This begs the question: when will you feel comfortable coming back in? It’s quite likely that you’ll buy back in only after equity prices have risen above where you sold. What are you likely to end up doing? Buying high after selling low.
Yes, you have taken action. But it’s important to remember that although progress cannot be achieved without action, action itself is not progress. Changing your investments in time with your emotional peaks and valleys rarely enhances your progress.
In fact, selling low and buying high is cited as the primary reason that individual, do-it-yourself investors significantly underperform both institutional investors and those who rely on firms such as LNWM for guidance when times get tough.