Corrections are an inevitable part of investing. Since 1932, declines of 10% to 20%, the traditional definition of a correction, have occurred on average every two years. The last one was in 2011 (though we came close in 2012). The physics of the market haven’t changed: What goes up can’t go up forever.
Substandard economic reports, hints of tighter monetary policy, significant weakening in Europe and geopolitical turmoil are all potential catalysts of a declining market. Though we are 5 years into a bull market, there’s no guarantee the market will brush off future disappointments. As I have discussed in past commentaries, orderly downturns are not just a normal part of investing but healthy for the markets providing good opportunities for active investors to reallocate capital and giving those investors who have nervously stayed on the sidelines, a chance to become more involved.
We have experienced what I would consider a stealth correction already in small cap stocks with the Russell 2000 down 10% since it’s late June highs. A closer look at the market shows that some sectors have already taken big hits such as Internet services and Biotech. Generally small caps lead the markets both higher and lower so if small caps are any indication, the broad market looks to be heading lower in the near term.
If we continue to see the market slide, I encourage my clients to turn off the TV. If a decline starts to snowball, you’ll hear about it—over and over. Don’t become your portfolio’s worst enemy by allowing yourself to get caught up in the negative hysteria. Instead, remind yourself that the market has experienced 20 drops of 10% to 20% since World War II (plus 13 bear-market tumbles of at least 20%). We are not just passive investors being blown this way and that by the winds of the market. We have an investment strategy that is being executed based on our expectation of volatile markets; an investment strategy that was formulated with clear heads, before the markets hit all-time highs, and before significant volatility hit the markets.
Over the past couple of quarters as stocks continued to hit record highs, we have taken significant profits from our strong performers, removed underperformers, and used the cash to build a reserve. This reserve provides insulation against a dropping market, and also provides liquidity for opportunities that present during down markets. I intend to have all client accounts prepared to deploy cash into value-focused dividend-paying stocks, should we see a 10% – 15% decline in the broad based markets. Each individual investment will be analyzed on its own merits not just based on broad market movements.
For each individual household the Harding Financial Group works for, I maintain a “shopping list” of investments that I believe would complement existing positions within the portfolio. Should we experience a significant decline, I’m looking for opportunities to establish or add to the following positions: In the healthcare sector; Wallgreens, CVS, Gilead Sciences. In Aerospace & Defense: Northrop Grumman, Boeing, Ratheon, Lockheed Martin, Alliant Technology. In Energy: Kinder Morgan, Energy Transfer Partners, Halliburton, Exxon and Conoco Phillips.
The above list is not all inclusive but those named are the positions appearing most often on client shopping lists. It has been several years since my total list has been so long. There are decent opportunities out there now but there will be great opportunities in the not too distant future.
The Harding Financial Group will not be complacent. I am committed to executing a sound investment strategy, minimizing emotional decisions and remaining focused on the long term goals of each family.
I appreciate your business and if there is anything we can do for you please don’t hesitate to contact our office.
Michael R. Harding, CFP
President / Portfolio Manager