The Trump Dump: What We Learned
Justification for the recent market downturn and a moment to ask yourself if you're prepared
Leading up to this year’s Super Bowl, the stock market was on edge with volatility not seen in many months. As tired Americans shuffled into work Monday, Feb. 5, stocks created additional pain beyond the Super Bowl hangover with a 1,175 point drop in the DOW – the worst single day point decline in history. Three days later, on Feb. 8, the stock market crashed with another 1,033 point loss in the DOW, sending the market into correction territory. With sudden amnesia, the media acted as if stock market corrections were a rare event and the 24-hour cable news cycle was off and running. The reaction of novice investors varied dramatically with some acting like deer in headlights, others remained over confident, while many scrambled in panic to move money into safety. It was clear many investors did not have a plan while they forgot market declines are normal in the midst of a bull market. Why did this happen? And what should investors do to prepare for the next correction or bear market?
STOCK MARKET CORRECTION
A correction is a drop of 10 percent or more in the stock market. On average, corrections happen every couple year, making them a common occurrence. The last stock market correction ended in February 2016. After a great market rally, the speed of the early February stock market correction caught investors off guard. This latest correction, called the Trump dump, should provide investors with a wake-up call. The last bear market, a loss of at least 20 percent, is almost 10 years in our rear-view mirror, the next correction might not stop so quickly.
WHY DID THE MARKET CORRECT?
Last weekend, I took a trip to Steamboat Springs to go skiing with my wife and three kids. We arrived at our vacation rental for the weekend with a feeling of excitement in the air. We woke up the next morning to a Colorado blue sky day with a fresh blanket of snow covering the mountains. As the kids put on their gear, they could hardly wait to get on the slopes. We skied hard that first morning and everyone was having a blast. We were having so much fun, time slipped away, and it was past lunchtime. After a morning of exertion and no lunch in sight, the kids were hungry, which turned into anger. The McNab family started to melt down. After lunch and a break from skiing, energy was restored, and they were ready to ski more.
Just like my kids, perhaps the stock market became hangry. Stocks have been exuberantly rising in a straight line since the election in November 2016. A rise in the stock market without a break is not exactly healthy. It has been two years since the last correction, making the markets overdue for a meltdown.
After a morning of skiing, the markets needed a lunch. A cooling off period is a good thing, bringing balance to the markets. This makes stocks cheaper and more attractive to investors, especially if the underlying companies are healthy, producing strong sales and profits. After the correction, the markets are now ready to ski again.
Although this may be the main culprit to the angriness of the markets, there is not a single factor which created this correction. The Trump dump happened for many reasons.
The markets adjusted to a combination of faster economic growth, higher inflation, higher interest rates and a more aggressive Fed. These are late-cycle trends which have generally been good for stocks but created a hint of uncertainty.
ARE YOU PREPARED FOR THE NEXT DOWNTURN?
Everybody has a friend, family member or co-worker who is going to tell you how they timed the stock market correctly. They predicted the market would decline and recommend a panic sell without knowing your financial situation. I have the psychological profile of this person memorized. If anyone predicts the stock market will decline long enough, their prophecy will eventually turn out to be true. While they are anticipating the markets to go down, there is an opportunity-cost lost while they sit in money markets waiting for the day they can brag to their friends about how they predicted this correction. I will also guarantee that they will not talk about the multiple investment mistakes they have made, or they do not recognize the opportunity-cost lost by their decisions.
When the markets are correcting, it is emotional for investors. After all, many see their dreams of retirement, college education or that cabin in the mountains slipping through their fingers.
A prepared investor has a professionally diversified portfolio based on financial dreams and risk tolerance. This includes creating a level of portfolio risk that maximizes the probability of success while running stress tests prior to market volatility to provide peace of mind during those rough market corrections.
I go to an auto mechanic to get my oil changed. I go to the barber to get my hair cut and I have an accountant complete my taxes. Yes, these are all things I could do myself, but I prefer to save time and have an expert do things right. Yet, millions of Americans try to invest on their own without the help of an expert while taking advice from cable news and the guy who says he knows everything about investing at work.
The stakes are too high.
Creating a plan with a professional portfolio strategy prior to the next correction will produce a fundamentally sound investor in all market conditions.
The next market correction is right around the corner. As the market heads into the final stages of the economic cycle, it has been almost ten years since the last bear market and recession. Investors take advice from cable news and friends hoping everything will work out with their financial dreams. Greed will overtake investors in a rising market who will get caught in the next downturn with an overly aggressive allocation. Prepared investors will diversify according to a plan, rebalance periodically, add value to a portfolio through common sense and make decisions based on facts, not through panicked emotional decisions. This latest correction is a wake-up call for all investors to get ready for the next bear market.