Is the 14-month rally about to end? Stocks are certainly showing signs of vulnerability, with the Nasdaq Composite (NASDAQINDEX: ^IXIC) now trading well below last month's peak, putting pressure on an important technical support level as a result. Charts don't matter in the long run, but in the short run, a small stumble can quickly cascade into a full-blown correction.
If this week's rough start is indeed an omen of what awaits us in the immediate future, there are some moves you can — and should — make before things turn from bad to worse.
1. Take a deep breath
Relax. Matters may seem terrifying at the time (and the mainstream media seemingly loves to fan those flames). The fact is, however, there's nothing the market can do here that is hasn't overcome before. Corrections happen, and usually don't do any lasting damage.
The proof: The S&P 500 (SNPINDEX: ^GSPC) has fallen 10% or more six different times since the current bull market got going back in 2009, with the 33% plunge suffered early last year the biggest among them. Not even that most recent drop could stop the bigger-picture uptrend.
That's not to suggest a short-term correction can't turn into a major bear market. As it stands right now, though, corporate earnings are growing as is the global economy. The International Monetary Fund estimated worldwide GDP will improve 6% this year and 4.4% in 2022. A market sell-off isn't apt to change that, and as such isn't apt to kick-start a true bear market.
2. Identify and shed your shaky holdings
Still nervous about owning a bunch of stocks? That's understandable. Be careful about wholesale shedding of your holdings, though. Timing the market is notoriously difficult, and trying to do it often does more harm than good. Investors can either end up missing the earliest part of any rebound, wait too long to start selling, or both.
There's nothing inherently wrong with pulling the plug on picks that aren't that solid to begin with, however. Figure out which of your stocks aren't everything they were supposed to be, and let go of them.
This is easier said than done. The process will require an honest assessment of a company's prospects that isn't impacted by your personal preferences.
3. Work your pre-developed pick list
While it can't hurt to sell your wobbly holdings when red flags start to wave, investors would be wise to prioritize buying rather than selling should stocks plummet. And to do this effectively, investors should have already developed a watch list of prospective stock picks to scoop up when they go “on sale” as a result of sizable pullbacks.
There's no right number of names to keep on a list of stocks to consider buying. Several dozen is probably too many, as it's too much to effectively monitor. Conversely, keeping tabs on only a few prospects may mean there aren't enough stocks to repopulate a portfolio when stocks dip. Ten to 20 prospects is a good target figure, knowing you probably won't be stepping into most of them specifically because of a price correction.
More important than the number of possibilities, however, is a list of any size that's been put together in a less stressful environment. We tend to make poorer decisions under duress. Take the emotion out of it by planning ahead.
4. Do nothing
Finally, perhaps the best action to take when the marketing is plummeting is also the toughest. That's doing absolutely nothing.
This isn't to say the aforementioned suggestions of selling your weaker positions and stepping into temporarily beaten-down quality stocks are mistakes. Neither of these moves, however, should cause a sweeping overhaul of your portfolio's makeup. If you've done your job right, most of your portfolio is already made up of the market's more resilient names.
Legendary investor Benjamin Graham arguably explained it best when he said, “In the short run, the market is a voting machine but in the long run, it is a weighing machine.” That “voting” reflects how investors currently feel about the apparent environment and its headlines, usually manifesting as fear or greed. The “weighing machine” is a nod to the market's ability to eventually properly price in the fiscal results that publicly traded companies are producing. This is the lens through which you should be looking at the market.
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