Yes, markets tend to show corrections from time to time

Kicking off February 2018, the stock markets saw a strong adjustment in the United States, only the S&P 500 index experienced a drop of 4.1%, the deepest since August 2015.

In order to get some perspective, this adjustment was 2.3 times stronger than the biggest fall observed in 2017. It is also worth noting that 2017 was a year characterized by low volatility in the financial markets.

Analyzing information for the S&P 500 in the last 30 years, this decline stacks up as the 33rd worst, over a universe of 7,827 daily observations. Within these considerable drawdowns, 20 took place between 2008 and 2009, while in 2011 we saw 4 during the month of August.

As a curious fact, 11 of these 33 falls occurred on Monday (apparently it is not the most popular day of the week). Now, studying the opposite effect, of the 33 best days of the S&P in the last 30 years, 12 were on Tuesday.

For a couple of years, the big question has been when will we see the next big correction, but, for some reason, this anticipated event has postponed its arrival, although it seems to have appeared in the last sessions.

It is usually difficult to link the trigger of these adjustments, or initiation of corrections, to a specific event before they occur.

Collective intelligence, in its eagerness to make sense of a random world, does not take long to show a narrative that attributes a perfect causality — in hindsight — to a large number of events. In other words: in retrospect, everything is exceedingly obvious.

In this case, the list of potential triggers includes factors such as: the imminent change in monetary policy within the Fed, the reduction in its balance sheet, the possibility of entering an inflationary environment, the level of public indebtedness in the United States, the stretched valuations of stock markets, among others.

None of this change overnight. All these possibilities have lingered around investors’ minds, and they themselves are responsible for assigning a probability of occurrence or impact, and then design strategies around their assumptions.

What usually changes — in a more capricious way than one would like — is the feeling that these events generate. Some of them seem to be imminent in the long term, but the way they are confronted is guided by optimism or collective pessimism.

Now, what to do in these situations?

It is essential to consider that the composition of the portfolios of each investor must obey their profile, as well as their investment objective.

Our exposure to equities should go hand in hand with our own long-term objectives, in which case, there is time for the market to resume its upward course. Whats more, there are even opportunities to increase positions or participate in stocks that “went away”.

A few years ago, early 2010 to be more precise, a dear friend and one of my early mentors, Alberto Rodríguez Govela, recommended one of my first books on Behavioral Finance: The Little Book of Behavioral Investing by James Montier. At the same time, Alberto told me that market corrections can be an ideal time to start building positions on companies that, due to valuation issues, for example, we had previously resisted entering..


As such, he suggested having a list of that kind of companies always present, and setting a price where I would love to participate (probably 20 or 30% below current prices) then program a buy order with that strike price. Alberto told me that this implies great discipline — probably if the stock reaches that price you will no longer want to enter. In addition, the decision must be made in advance and with a cool head, and most importantly, with a broad investment horizon.

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