By Jeremy Wallace and Andrew Hart
If you’ve been paying attention to the news, you know the markets have endured a topsy-turvy month of January. As a result, the S&P 500 and Dow Jones are both on the verge of what analysts call a market correction. (1) (Something the NASDAQ already entered last week.) (1) Should this volatility continue, you’re likely to see that term a lot in the days ahead.
Headlines proclaiming a market correction can often look very scary. That’s a problem because fear is every investor’s worst enemy. It’s what drives investors to make irrational and shortsighted decisions instead of sticking to a coherent strategy. So, in this message, I’m going to briefly cover some of the causes behind the current volatility before providing a refresher on our investment strategy.
What Is a Correction?
Quick refresher in case you’ve forgotten or are unfamiliar with the term: A market correction is defined as a decline of 10% or more from the most recent peak.
Corrections are fairly common. Prior to this month, we’ve had 10 since the turn of the century alone…of which three turned into bear markets. (2) They’re also generally short-lived, lasting three to four months on average. (3) But they still need to be taken very seriously, as we’ll cover later in this message.
There are two main issues driving the markets into correction territory. The first is an old story, one we’ve been dealing with for over a year now. The second is newer, at least to those of us living on this side of the Atlantic.
We’re referring, of course, to inflation and Ukraine.
Let’s start with inflation. As you know, the ongoing pandemic has wreaked havoc on global supply chains. This has caused prices to rise on everything from cars, to food, to toiletries. At the same time, the economy has expanded, partially due to the Fed keeping interest rates at historic lows. The result? Skyrocketing inflation.
Early in the recovery, the Fed hoped that inflation would be transitory, meaning temporary and short-lived. But inflation has proven stubbornly persistent. After all, COVID-19 has not gone away, choosing to spit out new variants instead.
For months, investors have been expecting the Fed to raise interest rates to combat inflation. (Higher interest rates slow the economy by encouraging consumers and businesses to save rather than borrow or spend. This, in turn, leads producers to lower prices to attract new business.) Now, in 2022, many analysts anticipate the Fed will raise interest rates several times this year. And it could happen as early as this week. The Fed is gathering for a two-day meeting on January 25, and investors are waiting with bated breath to see whether they’ll announce an interest rate hike.
Why do investors fear the prospect of higher interest rates? Well, low interest rates mean that many securities, like bonds, simply don’t provide the same return on investment as they would in a high-interest-rate environment. That drives more into the stock market to get the returns they need. Higher interest rates could potentially reverse this trend, leading to money flowing out of the stock market and into other areas. When that happens, stock prices typically fall.
For these reasons, the interest rate/inflation story is unlikely to go away anytime soon. But now the markets have a new question mark to deal with: the prospect of Russia invading Ukraine.
Now, this is hardly the place to dive into the long and controversial history of Russian–Ukrainian relations. So let’s just cover the basics. In recent weeks, Russia has moved over 100,000 troops near the Ukrainian border. (4) This has NATO—of which the US is a leading member—understandably concerned. (Remember, Russia forcibly annexed Crimea from Ukraine back in 2014.) All the major nations in the region are currently engaged in diplomatic talks, but the situation is growing so serious that the U.S. has ordered all family members of embassy personnel in Kiev to leave Ukraine.
Compared to inflation, it may be hard to see why this story has any effect on the markets at all. The reason can be boiled down to a single word: uncertainty. Will Russia really invade Ukraine? No one’s certain. What would happen if Russia did? No one’s certain. What will the U.S. and other Western countries do about it? No one’s certain. If, theoretically, the U.S. were to levy sanctions against Russia, or prevent Russian banks from doing business with the U.S. financial system, what would that do to global trade? No one’s certain.
The markets hate uncertainty. When investors encounter it, they tend to draw the curtains, head for the hills, and circle the wagons. So, when you see a broad selloff after news like this, keep in mind that it’s not because investors know what will happen. It’s because they don’t.
Historically, geopolitical events tend to have a very short-lived effect on the markets. That’s because, as the situation clarifies and uncertainty is replaced by understanding, the markets will settle down and go back to focusing on more domestic concerns. However, our team will keep a close eye on this. If the Russia–Ukraine crisis continues to impact the markets over the coming weeks, we will cover the subject in greater depth in a future message.
Uncertainty drives fear, and fear drives investors to make irrational decisions. The media often likes to portray shortsighted decisions as being solely about “selling instead of buying,” but we know from experience that the reverse can also be irrational. In fact, one of the worst mistakes investors can make is buying and holding regardless of market conditions, because they assume the markets will always go up over the long term. (Ignoring, of course, all the times they don’t.)
Here at Wallace Hart Capital Management, we know that, while corrections are common and often temporary, they can worsen into bear markets. Furthermore, any decline can have a significant impact on your portfolio, and by extension, your financial goals. So, while we don’t believe in panicking whenever a correction hits, neither do we believe in simply standing still. For this reason, our strategy calls for us to:
- Analyze market trends instead of simply market headlines. Is a particular investment, asset class, or the market as a whole trending down? If so, what are the underlying causes? And, most importantly, how is it likely to impact your money?
- Follow our rules that determine at what point we decide to buy, and at what point we decide to sell. For example, if an investment gives us a sell signal, we follow “the rules” and sell. Period.
- Be prepared at any time to “switch to defense” and move to cash to protect against losses and keep you from backsliding on the road to your financial goals.
Uncertainty abounds in the markets right now, and nobody knows with certainty what will happen. We’re no exception. But unlike the average emotional investor, or average buy-and-hold investor, we don’t focus on that. Instead, we focus on how things are trending now. We then follow our rules.
And that is how we deal with market corrections.
We’re Here for You
If you have any questions or concerns that we didn’t address in this message, please feel free to contact us. In the meantime, always remember that our team is here for you. From inflation to Ukraine and everything in between, we’ll keep monitoring the situation, so you don’t have to…and inform you immediately if there’s ever anything else you need to know.
Jeremy Wallace is founder and chief investment officer at Wallace Hart Capital Management, an independent financial services firm committed to offering comprehensive advice and customized services. Jeremy has 20 years of experience in the financial industry and is passionate about helping clients preserve and enhance their wealth so they can pursue their passions. Jeremy graduated from Emory University with a degree in international economics and a certificate in financial planning. Outside of the office, Jeremy spends most of his free time with his wife, Julie, and their three children, Isabel, Lincoln, and Reid. He is an avid Chicago Cubs baseball fan, and he enjoys golfing with his wife and traveling with his family. Learn more about Jeremy by connecting with him on LinkedIn.
Andrew Hart is co-founder and chief planning strategist at Wallace Hart Capital Management, an independent financial services firm committed to offering comprehensive advice and customized services. Andrew has 15 years of experience in the financial industry and strives to provide new and better strategies and processes to improve his clients’ lives. Andrew graduated from Wittenberg University with a bachelor’s degree in business management and holds a certificate in financial planning from Georgetown University and the CERTIFIED FINANCIAL PLANNER™ certification. When he’s not working, you can find him enjoying the city of Lexington, Kentucky, teaching at the University of Kentucky’s Financial Planning program, and spending time with his wife, Susan, twin sons, George and Ted, and daughters, Merritt and Philippa. To learn more about Andrew, connect with him on LinkedIn.
(1) “Dow, S&P 500 and Nasdaq all in ‘correction’ territory as inflation and geopolitical tensions flare,” CBS News, January 24, 2022. https://www.cbsnews.com/news/stocks-s-p-500-dow-nasdaq-correction-inflation-russia-ukraine-2022-01-24/
(2) “What is a stock market correction?” The NY Times, January 24, 2022. https://www.nytimes.com/article/stock-market-correction.html
(3) “Correction,” Investopedia, updated January 24, 2022. https://www.investopedia.com/terms/c/correction.asp
(4) “How Russia’s Military is Positioned to Threaten Ukraine,” The NY Times, January 7, 2022. https://www.nytimes.com/interactive/2022/01/07/world/europe/ukraine-maps.html