A stock market correction is an inevitability. In recent history, we saw two 10% corrections in 2018, a 13% correction in 2016, a 12.4% correction in 2015, a 20% correction in 2011, a 16% correction in 2010, and a -57% correction in 2009.
Then of course, we saw the fastest correction in history, a 32% correction in just one month in March 2020. At least I wrote about investing in the bottom then.
Whenever there is a stock market correction after long periods of stable growth, it always feels bad. Although it’s never fun to lose money, it’s good to face the situation head on and focus on the positives and what we can learn.
With valuations so high in the S&P 500 today, expect another stock market correction in the near future. Margin debt is way up, which makes me worried.
Silver Linings Of A Stock Market Correction
1) A catalyst to finally learn about risk management. If you’ve only been investing since 2009, the path towards building stock market wealth has been relatively straightforward. I argue its been too easy for the 35 and under generation to build wealth, thereby creating a false sense of security. Being overconfident in your investing abilities can be devastating once you’ve accumulated a large nest egg.
2) The ability to accumulate stocks at lower valuations. The keyword is “valuation,” and not price. If the price is lower by 10%, but earnings are cut by 10%, then you’re paying the same valuation for a stock. But if prices move 10% lower and earnings come out the same, then you’re getting yourself a deal.
The consensus 2018 S&P 500 earnings estimate is ~$155 (+17.8% from 2017). Therefore, at 2,500 on the S&P 500, the market is trading at a reasonable 16.1X forward earnings vs. long term average of ~15X. The consensus earnings expectation for 2019 is for earnings to grow by another 10% to $171, or 14.7X 2019 earnings.
The trillion dollar question is whether earnings will grow as expected, fall short, or exceed expectations. Valuations are generally considered “reasonable” if the P/E to Growth ratio is around 1X e.g. 15X P/E and 15% earnings growth.
Except for the rise in the 10-year bond yield to 2.85%, there was no other fundamental news that wasn’t already out there that could drastically affect earnings. Therefore, at the moment, it looks like investors are getting a valuation discount. And from a bond investor perspective, you’re receiving higher yields.
3) It takes time for corrections to play out. According to analysis by Goldman Sachs, since WWII the average correction is -13% over a course of four months. It then takes an average of four more months before the S&P 500 recovers all its losses. In other words, don’t use all your dry powder all at once if the stock market is down 10%+ in just a couple weeks. Rather, leg in through multiple tranches because timing the market is too difficult.
If you have a long-term mentality, you’ll be able to better contain your rush to sell and rush to buy.
4) A return to humility. Every time I write an article about investing, without exception, there will inevitably be someone who comments or e-mails saying how much money they’ve made in the stock market or how they timed a trade perfectly. Over social media, we witnessed a phenomenon of older folks bragging about their $1,000,000+ 401(k) balances. And younger folks love to shout from the top of their lungs how much they make every month online. After a while, this starts to get old.
Financial writers, like yours truly, will also begin to write with more humility. A downturn helps remind me that the focus of Financial Samurai is on learning so we can become better investors, better partners, better citizens, and ultimately happier thanks to the freedom money buys. My finances are used for illustrative purposes only because nobody should give a damn about my wealth except for my family.
As investors, it’s important to constantly remind ourselves that over the long run we are not smarter than the market. We must not confuse brains with a bull market, nor should we confuse stupidity with a bear market.
5) You don’t feel as bad selling risk assets too soon. One of the most difficult things I had to overcome when selling my SF rental house was accepting that I was probably selling too soon. In my mind, owning San Francisco real estate is a multi-decade no brainer. But I couldn’t take being a landlord anymore, especially after rents fell 10%+.
After I sold in mid-2017, the stock market continued to go up. To not be left behind, I re-invested my house sale proceeds into stocks, index funds, muni bonds. and real estate crowdfunding. But I took $815,000 in exposure off the table by wiping out a mortgage.
Now that the stock market is going through turbulent times, I feel great having sold. I’d be more stressed out today if I held, knowing that I passed on a great offer worth 30X annual gross rent, received less rent, and had to deal with maintenance issues and problem tenants.
6) You feel great holding cash. Despite reinvesting my house sale proceeds, I still was left with about $300,000 of cash (out of $1.8M) plus a 3% yielding CD worth about $184,000. When the markets are going up, you feel bad that your cash is earning you practically nothing. But now that the stock market is going down, having lots of cash feels like the best thing ever! It feels amazing to have an asset that doesn’t lose money.
After the S&P 500 corrected by 10%, I deployed half my liquid cash stash. I plan to deploy the other half if the market corrects by another 10%. With interest rates up, I can easily find a new risk-free home for my CD proceeds with the same rate. Cash management is all about stress management!
7) A chance to finally build your long shot. If it wasn’t for the 2008-2009 financial crisis, Financial Samurai would never have been born. Without Financial Samurai, I wouldn’t have been able to have as much carefree freedom as I have today.
The downturn made me fear for my job and my wealth so badly that I finally decided to do something about my fear. We’re nowhere near financial crisis-level panic today, but the correction that began in February 2018 reminded me of the stress I felt 10 years ago.
If you depend on only your job and your investments to keep you financially secure, a violent correction is the perfect time to start brainstorming new ways to make money.
Yes, it helps to whip your spouse into working harder and longer so you can just relax. However, spouses sometimes also could lose their jobs and investments.
For most people, investments should be considered a tailwind for financial growth. Building a business where you own most of the equity is how you can build next level wealth. It’s harder to get rich working for someone else.
But if you don’t want to venture into entrepreneurship, do well at your job. Get regular raises and promotions and aggressively save and invest for the long term.
A Refocus On What Matters Most
If you are not careful, a stock market correction can suck up all your time. It can make you a little crazy. During one of the -4% days I realized I was already on my computer for 2.5 hours straight watching the markets burn. I was reading everything I could about the why, the what next, and what to do. Don’t let a stock market correction take over your life!
Once I realized my glued obsession, I shut my laptop. Then I went downstairs to see my wife and son, gave them both big hugs and kisses and started to play. After all, the point of financial freedom is to not worry about money.
In 20 years, this correction won’t make a lick of difference. Don’t forget to enjoy your life during the process. If you need me, I’ll be finishing up my underground bunker just in case the world comes to an end.
Recommendation To Build Wealth
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