On average over time, market corrections occur roughly once every two to three years, making the extended period until last week without one unusual. Three things are important to remember during stock market panics. First, these are completely ordinary market events that serve the usual purpose of chasing less committed equity investors to the sidelines. Second, in time stocks will completely recover their lost ground, so anticipating that recovery should be our focus now. Which leads to the final important point, and that is the fact that market panics create exploitable opportunities.
The most obvious opportunity is to rebalance asset mixes back to target allocations, which means selling some stable assets and plowing those funds into temporarily depressed stocks. Another similar opportunity is to rebalance equities toward the ones with best recovery potential. The types of stocks that selloff the most during a panic are the same ones that rebound the most vigorously during recoveries. This creates a relatively brief but highly attractive trading opportunity. There are other more aggressive responses as well, but these first two opportunities should be exploited first.
Our ambition should be to come out well ahead when this stock market panic/recovery cycle completes its course.
Lowell D. Pratt Jr., CFA
