Understanding the dynamics of a Correction
The stock market is in the midst of a violent correction in prices. To be clear, a “correction” is a drop in the major indexes of 10% or less, while a “bear market” is a drop of more than 25%. (If you’re wondering if there’s a name for losses between those two numbers, join the club.)
As of now, the S&P 500 is down just under 5%. It feels worse than that. And every time this happens, worries about something worse happening increase. As long-term investors, we work hard to avoid worrying about these types of short-term pullbacks, recognizing that in a normal year the market falls between 5% and 10% twice.
But returning to our headline—Who is Selling?
- Short-term traders. The dramatic rise in prices since the beginning of 2023 creates powerful temptations to “take profits”. That’s how corrections begin.
- Short-term “investors”. At least the “traders” mentioned above are honest about what they are doing, but this group professes to be “investors” while worrying about every wiggle in prices. They are not investors.
- Those who believe that avoiding any level of loss is the secret to doing well in the stock market. This group is highly susceptible to marketing messages that promise to provide “downside protection”.
- Investors with debt. Whether it is margin debt or other forms, debt can force stockholders to sell in order to meet their obligations to creditors. Long periods of rising prices such as we have experienced lately, increases the attractiveness of debt. Falling prices do the opposite.
There’s a lot of overlap between these groups, but interestingly (to us) is that corrections begin with greed (lock in profits) and end with fear (oh my God!).
We believe that the key to long-term success in stock investing is to ignore the prospect of corrections and fight the fear that corrections induce. At Dock Street we are not immune to the emotions connected with owning stocks, but we view our primary responsibility to our clients to avoid indulging in actions prompted by those emotions.
Best regards,
Daniel A. Ogden
Dock Street Asset Management, Inc. is an investment adviser registered with the U.S. Securities and Exchange Commission. You should not assume that any discussion or information contained in this letter serves as the receipt of, or as a substitute for, personalized investment advice from Dock Street Asset Management, Inc.
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