A correction is coming! (what does that mean?)
Correction: it’s a word I’ve been reading and hearing a lot recently, and it really seems to be freaking some people out.
“The market feels rally high right now. Should I pull my money out before there’s a correction?”
“I read that stocks are totally overbought, and there’s too much froth in the market. Aren’t we due for a correction? Should I sell now?”‘
“The market is so volatile right now. Doesn’t that mean we could see a correction soon? Time to get out?”
First off, I’m really not the guy to ask for investing advice. I’m the explainer guy. If you want to know how things work, I’m your man. If you want a judgment call on what to buy or sell and when, I’d go somewhere else.
That said, if I explain what a correction is, it might help you make that investment decision. A correction, as the video above explains, is a short-term downward movement in the market. That market can be a share or an index or an entire market of shares or bonds or commodities or whatever. And it occurs when investors have gotten ahead of themselves. Perhaps they got too enthusiastic about the economy or the sector or, in the case of an individual security, even the company itself. Which mines that corrections are happening in the market all the time. That up and down movement in the price of an individual share? That’s a correction. It’s the market returning to reason, and pricing a security based on its fundamentals, rather than on what everyone else is doing.
And when it comes to a market, it often really is what everyone else is doing that drives a correction. Investors see their peers doing something, so they follow behind. It’s called riding the wave, and as every surfer knows, once you’re on a wave, it takes considerable skill to exit the thing before it closes out and buries you. Those “wave rider” investors are the people who are most worried about a correction because they’re not buying on based on fundamentals, they’re buying in because – and only because – the market is bubbling up. Which means they need to get out before it calms back down. Most retail investors, like you and me, are not in the market for the short term gains. We’re in it for the long haul, so while we like it when the market peaks, we’re generally not too worried when it dips again. Even when the dips are quite deep and sharp. The important thing for us is that the overall trend is upwards.
Right now, we are seeing a lot of wave-riding in the market. But there’s one other big reason to think that a correction might be coming. It’s that there’s a lot of hot money in the market right now. Hot money is cash that is looking for the best returns. Period. And right now, pretty much the only place that’s showing good returns is the stock market. Interest rates are still super low, so bonds are no good. The housing market is still struggling, so real estate, with some notable exceptions, is still slack. Commodities are sluggish, thanks to the slowdown in global growth. So the stock market is really the only game in town. And that’s attracting huge amounts of money, money that will go elsewhere as soon as a better opportunity arises. And when that money flows out of stocks, we will definitely see a correction. Investors will sell, the market will drop, and share prices will return to levels based on company fundamentals again.
And voila. Buying opportunity!