Corrections – And Fear of Them – Can Be Threatening

American markets today, Monday, viewed several hours before the 9:30 a.m. EST opening look poised to start strongly positive with the S&P 500, Dow and Nasdaq all firmly rooted in the green. It would not be surprising if new records are set this week.

That follows Friday’s session which closed with major indices down as investors worried about inflation and digested a court ruling allowing iPhone apps to provide a link for customers to bypass Apple and pay developers directly. Apple closed at $148.97, a drop of $5.10 or 3.31% on the day but is likely to recover today. Apple holds a special event tomorrow, likely focusing on its new iPhones and possibly driving up its shares.

Canadian markets look set to open positive with the TSX 60 also firmly in the green at time of writing.

European markets are open at time of writing and are in positive territory with the FTSE 100, DAX and CAC 40 all in the green.

Amongst precious metals the safe havens of gold and silver are down.

Amongst currencies the British pound sterling and Euro are down against the American greenback while the Canadian dollar is up.

Whether the markets return to piling up record highs this week remains to be seen but some cooling during this month would also not be surprising especially given the continuing debate over the so-called tapering.

Put simply, the Federal Reserve Bank has several tools for stimulating the economy but the two that have attracted the most attention are dropping interest rates and purchasing government-backed debt. These two tools are often discussed together but in fact can be administered separately: the Fed can start tapering (reducing debt purchases) separately from raising interest rates (and likely will do so).

The market is very nervous these days. Whenever it dips dramatically, as it did during both July and August, proving again its continuing volatility, comments on some trading sites run to the ‘C’ word.

Fears of a correction are justified but a strong dip is not an across-the-board correction. Worrying about a correction is like worrying about bad weather. It will come sooner or later and taking steps to deal with it by improving the insulation around windows and doors and even around the garage is more effective than fearing the bad weather to come and doing nothing. Increasing the insulation amounts to a recognition that there will be bad weather but that you have done what you can to shield your home from the storms.

Certainly, corrections – and the fear of them – can be frightening, especially at the prospect of damage to a retirement that the investor has been building for some years. It’s reasonable to believe that uncertainties and volatility will continue. School closings, new COVID variants, more surges, the risk of a vaccine-resistant variant, workplace issues about mask and vaccination mandates and other problems all seem possible.

Still crashes, heart-throbbing though they may be, are normal and it’s most likely that the market will recover and in fact has recovered from all downturns in recent history.

The S&P 500 is up 21% this year and while it would be delightful, that pace will not likely continue.

It is reasonable to have a healthy concern about the possibility of a correction. The insulation strategies can start with a recognition that the returns of the recent months are not likely to repeat again. In fact, some stocks are arguably overvalued, and the possibility of a correction cannot be dismissed. A CNBC analysis says that the average correction for the S&P 500 since World War II lasted four months and saw equities slide 13 percent before bottoming. By comparison, bear markets average a loss of 30.4 per cent and last 13 months and it takes stocks nearly 22 months on average to recover.

Some fearing a correction might be tempted to go to cash. However, there are some harsh realities to consider, starting with the bite from inflation. If you sell your stocks and go to cash and leave it in the bank in low-interest bank certificates or even brokerage accounts, it erodes in value.

The consumer price index increased 0.5% in July after climbing 0.9% in June, according to the United States Labor Department. For the year ending on July 31, it advanced 5.4%. The lower increase for July provided some support for the Federal Reserve Bank claim that the spike in inflation is temporary and likely to fade as the categories that caused inflation to surge in recent months get back on an even keel, according to a Reuters analysis.

Still, going to cash exposes your funds to inflation, however correctly or incorrectly the Fed views recent numbers.

To the extent that inflation increases, so too does the erosion of funds in low interest certificates or accounts. Shifting to value stocks is a safer solution than shifting to cash.

Leaving funds in cash also leads to what is known as an opportunity cost: that is, you are foregoing the yield that you might have received by leaving the funds invested. So, the total cost of leaving large amounts in cash is inflation plus opportunity cost. A possible strategy here could be a broad-based index fund.

While it has periods of ups and downs, the long-term trend is for the market to continually rise higher, producing positive returns for patient investors. Also discuss with your financial advisor whether it would be appropriate to take some profit from tech stocks and invest it in companies likely to weather any storm, such as Costco or Visa or Bank of America. (I am not specifically recommending these stocks but suggesting them for discussion between client and advisor.)

Rebalancing the portfolio is another strategy for consideration. This may mean including a limited amount of non-volatile assets such as bonds.

Related: When Will Inflation Lift Off?

Disclosure: I do not own any shares in any company mentioned in this column.

Al Emid is a financial journalist broadcaster and author. His next book. The 2022 Emid Report on Volatility provides a map for navigating market tumult and is scheduled for release in January 2022.