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Monday, September 20th, the S&P 500 sold off 1.7%. It was painful to watch. By Friday, the market recovered the losses and ended the week higher. The primary reason for the sell-off was the potential loan default of Evergrande, a Chinese property development company that few had ever heard of. There was fear that the problems at Evergrande could be a symptom of a bigger problem. Over the week, global financial institutions assessed their exposure and the risk of contagion. All indications are that the financial risks are limited and could be mitigated by the Chinese government.
At the end of their October meeting, the Federal Reserves' decision not to raise interest rates or begin tapering their bond purchases calmed markets. In the press conference, Federal Reserve Chairman Jerome Powell struck the perfect balance, assuring markets that they were aware of rising inflation concerns but would remain accommodative until they were confident that the job market had stabilized. The Fed lowered their 2021 GDP forecast to 5.9% (down from 7.0% in June) and raised their GDP forecast for 2022. They acknowledged inflation is running higher than anticipated. The Fed believes that some of the inflation is temporary and will moderate once supply chains have healed.
In investing, two of the most important things to control are our emotions and our expectations.
Expectations - Market pullbacks can be unpredictable but should be expected. In this chart, we see that since 1980 there have only been three previous years without a pullback of 5% or more. There have not been two years in a row without such a pullback. A drawdown of 5% or more before year-end would be typical. To go the next 15 months without a correction of 5% or more would be a statistical anomaly.
Emotions – When markets make sharp corrections, it is normal to feel anxious. Those who have invested through recessions are reminded of how they felt during those times. Drawdowns of 20% or more that last for more extended periods, called bear markets, are often associated with slowdowns in the economy or recessions. It's important to remember that every correction does not lead to a bear market. Before making an investment change during a market pullback, separating facts from feelings is essential. Consider all the economic data to recognize the difference between a normal market correction and a market signaling future economic weakness. Emotionally driven financial decisions often don't end well.
Finally, we can be tempted to try to predict market corrections. To successfully time the market means you must be right twice. You need to know when to sell, which would be at a market top when everything seems fine, and then you would need to know when to buy, at a relative bottom when things don't feel so good. Market timing is a fools' errand. Those who have tried to time markets have lost more money than they would have lost in the correction.
At this time, I do not see any economic data that suggests we an economic recession in the foreseeable future. I will of course provide an update if I see anything that changes my view. Market corrections can be unsettling but are part of regular market activity and should be expected. Acting on changes in economic data rather than our emotions leads to better financial outcomes and less portfolio-related stress in our lives.