Over the last few years you have ignored the nay-sayers who incessantly predicted stock market, real estate market, and economic crashes. You stayed in the market and have seen a rather nice increase in the value of your investments. However, all good things come to an end and those things include bull markets. But, after every stock market correction there will be a rebound. What are some smart ways to predict a correction and protect your investments in order to profit from the next upswing?
Market Corrections and Recoveries
Is There a Correction around the Corner?
There are signs of a market correction that you can watch for.
When the market keeps going up too many investors become impatient, looking for more and more profits. They forget risk management. An old piece of investing advice is that you do not have a profit until you take a profit. If you have done well with a volatile stock there is nothing wrong with taking a little profit, paying long term capital gains and holding on to cash until the market offers great deals again. Prior to the burst of the dot com bubble several well-known investors stated that they were essentially cashing out of the stock market because it made no sense. These folks were able to re-invest at very attractive prices a year or so later.
Today, according to CNBC, Deutsche Bank is cautious for the near term and expects a 3 percent to 5 percent pullback but a rebound later in the year.
Citigroup makes a similar prediction as reported in the same article. They use a proprietary formula that takes into account a brewing trade war, geopolitical uncertainty, Federal Reserve policies, and spreading weakness in emerging markets as part of a creeping economic weakness internationally.
There Is Always a Recovery, Somewhere
After all stock market crashes in recent memory there has been a market recovery. The S&P 500 fell from 1500 to 900 between September of 2000 and the beginning of 2003. Then it steadily rose again to a peak of 1560 before the financial crisis. At that time it fell to 680 by March of 2009. And, from there the index has climbed steadily for nearly a decade to 2870 today.
As we noted in our “signs of a market correction” article, smart investors decided that the market made no sense in the run-up to the dot com crash. And, smart investors saw the dangers of over-leveraged investments going into the financial crisis and got out. These folks all re-invested after the crash and resumed earning profits.
If you are a passive investor and just invest in index funds that track the S & P 500, you can expect the results like we just showed you. But, there were a lot of weak stocks with really poor intrinsic value going into both the dot com and financial crisis crashes. These stocks inflated the prices of index funds going into a crash. And these companies commonly went bankrupt and disappeared from the index after the crash.
Over the long term it is financially dangerous to follow the “rising tide raises all ships” method of investing. The stocks of strong companies go up because of strong earnings, strong products, and a margin of safety in the form of money in the bank and minimal debt. A company selling in the same market niche may see its stock go up based more on optimism than a fundamental-based promise of growth. Two stocks today that raise concerns are Facebook and Tesla. Facebook is looking at more regulation due to its prominent communication role in modern society and Tesla needs to start producing profits for investor get tired and start selling. Smart ways to predict a correction and protect your investments include culling out potentially dangerous investments, like Facebook and Tesla.