5 Lessons from the market correction

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Mark Draper (GEM Capital) recently contributed to an article that was published in the Weekend Financial Review in February - titled "5 Lessons from the correction".

We have permission from Fairfax Media to bring you the article on our website.

 

Thank goodness the week is over. The S&P 500 index in the United States suffered its two biggest points falls in history, while the local benchmark plummeted nearly 5 per cent in two days and then fell 52 points on Friday.

The falls seemed all the more dramatic because they followed such a long period of market bliss.

In the midst of the mayhem, it was easy to forget that the decline followed huge gains in stock prices last year.

But it is worth remembering just that. The S&P/ASX 200 rose from 5733 points to 6065 in 2017 and is now sitting at 5838. Its US equivalent surged 25 per cent last year, and on Thursday night closed at 23,860 – still 21 per cent higher than at the start of last year. So equity investors haven't done too badly.

It is also worth remembering what caused the crash and how short term – or long term – those causes might be.

The immediate catalyst was US jobs figures, which showed wages growing faster than expected and weekly jobless claims hitting a 45-year low, raising the prospect of higher inflation and interest rates.

Analysts also pointed to a deteriorating US federal budget as a secondary factor.

But some economists argue the wages data contains anomalies and could well be revised next month. Some also suspect the jobless figures might be overstated because data for several states were estimated.

Further, one of the presidents of the Federal Reserve, James Bullard, cautioned against drawing parallels between good news on the labour market front and higher inflation. The relationship had broken down in recent years and may now be non-existent, Bullard said in a speech.

It also appears that algorithmic trading programs exacerbated the sharemarket falls in the US, at least in the early part of the week. Algorithms are set up to react to certain conditions. A fall of, say, 5 per cent in the index, may trigger the machine to sell.

Reports out of the US suggest that many of the algorithms that sold equities on Monday were "selling short". In other words, they sold stocks to buy them back cheaper at a later date.

Still, this is not to say that stockmarkets – which have been turbo-charged by ultra cheap money since the global financial crisis – are off the hook. Experts say investors would be wise to learn the lessons that have been offered up this week. Here are five of them.

1. Make sure you are not a forced seller

Regardless of where financial markets are in the cycle, investors need to ensure they are not in a position where they have to sell stocks – which can happen if equity markets remain in the doldrums for a couple of years.

"Not being a forced seller and having cash set aside to get through difficult market periods is probably the best advice I can give," says Mark Draper of GEM Capital in Adelaide.

Being forced to sell can arise for several reasons.

Retirees may need to sell assets to finance their lifestyle, savers may be parking money in the sharemarket to buy property or investors may have borrowed to buy shares and face demands for loans to be repaid.

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