Don't Panic During Market Disruptions

A decline in the markets can be a frightening experience. As indices drop for days, weeks, or months at a time – questions flash through an investor’s mind. How long will this last? How much will the value of my portfolio decline? Is now the time to sell? These uncertainties are only amplified by sensational market headlines like “The Worst Week for Global Markets Since the Great Recession” or “Stock Market Slump: No End in Sight.”

Regardless of the dire picture painted by news outlets, a steep market downturn is a natural part of a healthy economic cycle. By definition, when markets experience a pullback of 10% to 20%, we call that a “market correction.” When that decline is larger than 20%, markets are in a bear market. While a market decline can be caused by many different factors, it’s often a signal that investor sentiment has shifted from optimism to pessimism, and as a result – overpriced assets snap back to more realistic prices.

What Causes a Market Correction?

Market corrections are common, and over a long enough timeframe, they’re a virtual certainty. But it’s impossible to predict exactly when they will happen and what will cause them.

Historically, market corrections have happened at times of recent market highs and elevated sentiment. The correction can be triggered by a national or global event that causes investors to worry – for example, fears over a widespread disease or uncertainty surrounding a presidential election. But, more commonly, there’s no single catalyst for a correction. They can happen seemingly at random, without any obvious cause. This makes them all the more difficult to anticipate.

Reacting to a Market Correction

Steep market declines and scary headlines understandably create nervousness and confusion. These jitters give rise to a vicious cycle of markets dropping, fearful investors selling, and markets dropping even more.

Those who remain calm and keep things in perspective are much less likely to be swept up in this negative feedback loop. Individual investors, as well as professional asset managers, who don’t panic during corrections are in a strong position to fare well. Those who sell during a correction lock in their losses to date and run the risk of missing out on any bounce back.

During market corrections, investors may also benefit from having actively managed funds in their portfolio. Certain passive-only investing strategies have the potential to expose investors to securities and sectors with weak fundamentals, making them more vulnerable to sharp market declines. Active management has historically offered benefits during times of volatility, as it allows the portfolio manager to take advantage of opportunities based on current market conditions. At Weitz Investments, all our funds are actively managed, high conviction, and backed by a thorough research process.

The Impact of Corrections

Fortunately, market corrections are usually a short-term event, occurring an average of once per year and lasting three to four months. The average market loss during a correction is about 13%, and historically, that loss has been recovered over a period of about four months. In the grand scheme of things, a correction can be little more than a blip on the radar for investors with a long-term focus. It’s important to note, however, that each situation is different, and it’s impossible to know exactly when the markets will turn around.

For a longer-term perspective, the table below shows performance of the S&P 500 index during and after significant macro events since the 1980s. Certainly, in each of the events below there were investors who were scared into cashing out. But given a long enough time horizon, these fear-fueled selloffs have all been erased. Imagine selling during these declines only to miss out on the market’s subsequent gains.

For yet another viewpoint, let’s look at how the bond market has fared during event-driven market disruptions. You will notice in several but not every case, bond prices moved higher during the event in question, and over the long term, the overall fixed income market experienced consistently positive returns after these events.

A Time of Opportunities

At Weitz Investments, we manage our portfolios with a focus on quality, price discipline and the long term. Our goal is to buy securities of companies that can sustain through, and take advantage of, market dislocations. We aim to buy when stocks and bonds are selling for less than what we think they are worth. This “Quality at a Discount (QuaD)” investment approach often means we add to our existing holdings during a market correction, which is an advantage of active management. We also see market corrections as a time to be vigilant of new buying opportunities. A sharp decline doesn’t necessarily mean we’ll be going on a shopping spree, but it may mean more attractive prices for companies on our radar.

In other words, market corrections may very well create buying opportunities, but our decisions are rooted in a company’s price compared to its intrinsic value – regardless of recent market activity.

There Will Always be Volatility

The only certain thing with investing is uncertainty. And perhaps the most troubling part of corrections is that they tend to happen at times of seemingly invincible markets. When incredible performance is interrupted, it’s natural to wonder how long the interruption will last. But it’s always important to remember that the simple concept of “buy low, sell high” is impossible without “low” times. When prices fall, you can either follow the crowd and sell – or you can be optimistic about potential opportunities.