While crashes are illogical, corrections are quite normal.
If a crash is defined by a fall in the sharemarket greater than 20%, then crashes are not normal occurrences. Since 2000, there have been 5 instances where the Australian market has fallen greater than 20%.
The largest of those was the Global Financial Crisis where the market lost 54% in value.
Corrections in the sharemarket can be scary but are a more common occurrence than your annual birthday. In the last 20 years, there have been 30 corrections in the market of a 5% fall or greater. In some years such as 2010, 2013 and 2016 it has felt like most of the year was a correction. 3 corrections occurred in each of these years.
History teaches us that these corrections are almost always a buying opportunity. It is to be expected that corrections take place when the market has been powering ahead so strongly. Falls of between 3% and 20% are only natural.
Here at Burman Invest, we have a proprietary asset allocation model which works on various technical and volatility indicators to show the likelihood of a correction being entered and exited. If a correction is due, what can we do to safeguard our portfolios?
Firstly, if we think a correction is due, we move some of our portfolio into cash. This then allows us to buy shares at a lower price during the correction.
Secondly, we look to protect our portfolio. There are a number of ways that we can do this during downturns in the market.
Whether it’s through the options market and buying a put for protection, having a stop loss in place to limit downside risk or just using diversification meaning your eggs are not in one basket but spread across regions, economies and asset classes.
At Burman Invest, we actively manage our options positions to hedge against corrections using puts.
Thirdly, for individual investors, shares with dividends act as a buffer against downturns in the market since investors get paid dividends regardless of whether the market is rising or falling. That is why stocks with high dividends are often also called defensive stocks; they act as a defence against a downturn in the market. When looking at shares with high dividends, I also like to see it backed up by stable or rising earnings to ensure that the dividend is not at risk of being cut.
The top three danger months are grouped together and are June, September, October. These 3 months have had the worst average returns over the last 30 years. June, September and February have had the most negative monthly performances in that period. No matter which way you measure it, September keeps popping up as a seasonally weak month for the sharemarket.
While we could still be in for more volatility ahead, history shows that corrections are perfectly normal and something that investors should utilise to the best of their advantage. After all, if the goal is to buy low and sell high, then it makes sense that corrections are a time when things are relatively low. So, diversify, protect your downside, and enjoy the volatility of the markets. Without it, we would not have the stellar returns that come hand in hand with the volatility.