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"In the investment business, you go to school every day, but never graduate." - Don Hodges

The Anatomy of a Correction

by Alan Ebright, on May 2, 2022

I enjoy taking difficult market-related subjects and breaking them down to simple form. As an advisor, I am in a continuous search to find various ways to explain concepts to clients. Not only does it keep my mind sharp, but people have different ways of hearing things, so I try to tweak things to resonate with most.

Rather than weigh in with my opinions regarding the current correction, I figured I would spend time telling you why you needn’t worry about this one or any other. The “why are we having a correction” is completely irrelevant, it’s how you behave that’s crucial. So, here’s my attempt to make an all-encompassing piece about market corrections. A playbook if you will. Something that you could read and re-read for years and years, and at the end say to yourself “Yep, this is exactly what’s going on.”

It goes something like this. Anywhere from 1-3 pieces of negative news hit, and they are largely unexpected. We’ll call them 1, 2, and/or 3. The first thing that happens is the market goes down immediately. It starts with the smaller/growthier stocks, then makes its way to the larger/dividend payers. Then the news outlets get hold of the story and tell you this is awful and “surely will have repercussions for the market and investors”. Then the financial news outlets line up their cast of doomsayers who, by the way, cannot wait to come out of the shadows. So, they fill up their 12 hours of airtime with these types, and what they’re saying sounds darn near 100% plausible because the market keeps going down while they’re talking; a self-fulling prophecy!

Enter the politicians, especially if 1, 2, or 3 is something that can be controlled by political persuasion, or better yet, votes. Plus, what politician doesn’t like the camera? So, we then must endure their take on the current market events, and most of it is twisted to bend the ear of their constituents.

Having run out of doomsayers, the news outlets now bring on the people who are bullish on the market and view this as a short-term aberration. Yet, they still dig up some naysayers to at least make the 12hrs more balanced. Plus, the market is still down, so the bullish camp still isn’t right, and why ruin a good disaster too soon? Now, having digested way too much news over the past week, weeks, or months, we still don’t know what to make of it. What to do now?

Might as well search online. If you’re the “bullish” type, you start searching for articles of hope to support your bullishness, but those aren’t easy to find. You’re also seeing pop-up ads for “What to Do in the Coming Depression”, “Buy Gold”, “Investment Solutions for Bear Markets”, but you probably cast them aside, because you’re looking for the positive news. If you’re “bearish”, you’re also seeing those same ads, only you’re clicking on them and possibly subscribing. Most of those links proudly showcase a plethora of negative commentary, again sounding very compelling (given the current state of things). What they are is a way to get you to purchase doom and gloom market letters, precious metals, annuities, or all three.

About the time that we just can’t handle any more negative news, the market starts to go back up, and in those initial days it can go up quickly. It’s also a virtual certainty that 1,2, and/or 3 are nowhere close to being resolved. Market corrections are always a ready, shoot, aim progression. What the market does is pre-price the negatives to the downside, and then when we come to realize that 1,2, and/or 3 are not as bad as we initially thought, the market starts to recover, and usually in short order.

Does this all sound about right? So, what is a remedy for a correction? Well, just accept that corrections happen, and they’re a normal part of a market function, and they always happen for different reasons. There tend to be 1-2 corrections every year, the magnitude of which can be anywhere between 5-20% down. The longer we go without a correction, the more severe they seem. If you figure that most people’s investing time horizon is from their late 20s to late 80s or even 90s, that’s 60+ years! In those years, one might witness 120 corrections. Keep this playbook handy!

What Should I Do?

For starters, reframe the way you think about investing and markets. “The market” is simply a way to access companies. So, instead thinking to yourself “the market is down”, think of it as an opportunity to buy companies that are on sale. One of the best quotes I have ever heard about corrections comes from the legendary Warren Buffet; “The market is a mechanism of transferring money from the impatient to the patient.” Impatience is pervasive during corrections, and a prime example of that mechanism at work. Next, you must make a deal with yourself on a level and an amount. Example: If it’s down X%, I’m putting in Y dollars, and then you DO IT! You can’t hesitate. You will probably never catch the precise bottom, but that doesn’t matter. You’ve just added to existing holdings or purchased new holdings at a discounted price.

Yeah, yeah. But how do I know if this isn’t the start of a crash….one of those down 30-40% events? Short answer: You don’t, and neither does anyone else. Here’s where you can pull from history and look to probabilities. In the 94-year history of the S&P 500 there have been only 6 times where it closed out the year -20% or more. 6 times in 94! That’s 6.3% of the time. Put another way, that’s 93.7% of the time it did not. Do you want to fight those odds?

So, go forward with confidence. View these corrections as flash sales and an opportune time to invest at temporarily discounted levels to enhance your long-term investing goals. Embrace the corrections because they’re never going away.

 

In the end, how your investments behave is far less important than how you behave. -Benjamin Graham

 

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Hodges Private Client is a program offered through Hodges Capital Management, Inc. (“HCM”).  HCM is an Investment Advisory Firm registered with the Securities and Exchange Commission (“SEC”), is a wholly owned subsidiary of Hodges Capital Holdings and serves as investment advisor to the Hodges Funds.  HCM is affiliated with First Dallas Securities, Inc, a broker-dealer and investment advisor registered with the SEC.

This discussion is not intended to be a forecast of future events and should not be considered a recommendation to buy or sell any security. Past performance is not indicative of future results. Investing involves risk. Principal loss is possible. Investing in smaller companies involves additional risks such as limited liquidity and greater volatility. No current or prospective client should assume that information referenced in this communication is a recommendation to buy or sell any security or is a substitute for personalized investment advice from your individual advisor. HCM does not provide tax or legal advice. Consult your tax or legal advisor for any related questions.  

All information referenced herein is from sources believed to be reliable and is provided as general market commentary and does not constitute investment advice. This material was created for informational purposes only and the opinions expressed are solely those of HCM.  HCM shall not in any way be liable for claims and makes no expressed or implied representations or warranties as to the accuracy or completeness of the data and other information.  The data and information are provided as of the date referenced and are subject to change without notice.

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