Yes, We Are Going To Have A Correction!!... Now Get Over It...

The stock market reached bottom in mid-winter, 2009. We are now in the sixth year of this Bull market. The rise in stocks has been very broad-based with most industries benefitting. And volatility has been very low. The chart below shows this is the fourth longest Bull run in the last 85 years without a “major correction” – or a dip of 20% or more.

But we can be sure that we will get a 10% or a 20% correction at some point. It may be caused by an event out of the blue, it may be caused by financial assets getting overvalued or it may just be caused by market exhaustion. We will have to wait and see.

Robert Shiller at Yale has developed what is known as the CAPE index – the ‘cyclically adjusted price to earnings ratio’, that averages P/E’s over a ten year period. The ratio stands at 26 today, a level that has only been exceeded at the market peaks of 1929, 2000 and 2007. Ugh, this is a big red flashing light.

Other analysts however argue that the P/E ratio based on current earnings or expected earnings in 2015, is only slightly above the long term average of 15x. In addition stocks do not seem expensive relative to competing assets such as the ten-year Government bond at 2.6% today.

Our take is the market is not in Bubble territory but that we should get mentally prepared for a 20% decline. It is going to happen. Investors were shaken by the fall in stock prices between 2007 and 2009. In 2006, 63% of Americans owned stock. Today fewer than 55% own equities. A lot of people got out of stocks and have never come back. Those that held on have benefitted but the test will be the next correction and whether investors stick to their long-term goals and allocations or whether they turn tail.

Selling in anticipation of a correction never makes sense. As Peter Lynch the famous portfolio manager at Fidelity Investments has said, “far more money has been lost by investors preparing for corrections, or trying to anticipate corrections, than has been lost in corrections themselves.”

Even Andrew Smithers, a well-known financial consultant in London and someone who thinks the market is overvalued today, thinks that the long-term investor should maintain a minimum of 60% in stocks. Why? The reason is that over time, and this includes both Bull and Bear markets, stocks return more than the alternatives such as bonds and cash. Stocks tend to go up six or seven years out of every ten, so the patient and committed investor benefits over the long term.

Finally, what did Warren Buffett write to his trustee about investing his funds after his passing? Put 10% in short term government bonds and the other 90% in a well-diversified S&P-like fund and “never sell when the news is bad.” Face it – the market is like a pendulum, swinging between overvaluation and undervaluation. We get corrections from time to time and this is a normal part of the cycle and far from the end of the world for the serious, long term investor.