As markets commenced a major U-turn a couple of weeks ago, major indices like the NASDAQ 100 have reached stock market correction territory. The common definition of a stock market correction is a decline of 10% from a most recent peak. Many investor darlings, such as NVDA 📈 or AVGO 📈are already in bear market territory, i.e. they have lost in excess of 20% since their peak.
How to position your portfolio in a highly uncertain environment
Investors increasingly start to wonder how to brace for further market declines in a highly uncertain market environment. In this post, we discuss the best options to navigate investing during a stock market correction.
What is a Stock Market Correction?
A stock market correction is a temporary decline of 10% or more in a major stock index, such as the S&P 500 or Nasdaq, from its recent peak. Corrections are a part of market cycles, often triggered by economic concerns, interest rate changes, or investor sentiment shifts, for example in response to political uncertainty. While they create short-term volatility, corrections also present opportunities for long-term investors to buy stocks at lower prices.
What Causes a Stock Market Correction?
A stock market correction can be driven by a multitude of factors, separately or jointly. The most frequently seen drivers are a rise in interest rates or a recession. But there can be other factors at play. Donald Trump’s policy announcements, whether it is tariffs or massive and completely unstructured cuts in the public workforce, have created a huge degree of uncertainty. Markets loathe uncertainty, which bodes badly for the near to medium term.
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How Should You Invest in a Stock Market Correction?
So what are the options for investors in this market environment? Here are the principal courses of action that investors can take – all the while, of course, keeping in mind individual circumstances, such as, risk appetite, age or income.
1 – Raise cash to position for bargain stocks
2 – Hedge my portfolio
3 – Sell all stocks and move into bond ETFs
Let’s examine these options in greater detail.
Option 1 – Raise cash to position for bargain stocks
If you are a long-term investor, who believes that further stock market declines are a real possibility, then raising cash to position yourself for buys at lower prices is a great option for you. With cash available to buy the dip you can take advantage of much lower stock prices for investor darlings, such as NVDA (-25%) 📉, MSFT (-17%) 📉 or AMZN (-17%) 📈 compared to just a few weeks ago. Opportunistic investors can prepare by pulling their favorite stocks into a watchlist to monitor and seize great bargains.
Option 2 – Hedge my portfolio
A great option is to hedge your portfolio. You may believe that hedging is just for professional investors. This may have been true in the past. However, today there are straightforward instruments for everyday investors that let you protect your portfolio in a single transaction and at a reasonable cost. For instance, with the ProShares Short S&P 500 (SH) you can protect a $100,000 portfolio at a cost of around 0.5% – 0-55% for a period of 6 months. SH is an inverse ETF, meaning it moves opposite to the S&P 500 (approximately -1x daily).
Example Calculation:
Total Estimated Cost: $545 (0.55% of total portfolio value)
Portfolio Value: $100,000
Investment in SH: $100,000
Six-Month Expense: $100,000 * 0.445% = $445
Compounding effect: $100,000 * 0.1% = $100
Option 3 – Sell all stocks and move into bond ETFs
The most radical option consists of selling all your stocks – and other high beta investments – for the benefit of investments in fixed income assets. Your best bet in fixed income are bond ETFs.
Also Read: Why consolidating all your investment accounts is critical for long-term investing success.
We highlighted some great options in this post. Corporate high yield bond ETFs, such as SJNK 📈, or loan ETFs, such as BKLN 📈, continue to be great options. At the time of this writing, SJNK yields 7.4% while BKLN yields 8.4%. Bond ETFs are considerably less volatile than stocks and in many cases even move in the opposite direction of stocks.
In essence, you can earn up to 8% per annum while sitting on the sidelines and considerably cutting down on your market risk.
Does a Stock Market Correction Mean The Start of a Bear Market?
Not necessarily. A correction is a decline of 10% or more from recent highs, while a bear market occurs when the market drops 20% or more. Many corrections are short-lived and do not escalate into bear markets, particularly when they are driven by temporary factors such as profit-taking.
Historically most corrections haven’t become bear markets. There have been 25 market corrections since November 1974, and only six of them became bear markets (which began in 1980, 1987, 2000, 2007, 2020 and 2022).
Chances of moving into a bear market are considerably higher in the face of prolonged uncertainty, whether economic or political. However, if a correction is accompanied by worsening economic conditions, declining corporate earnings, or widespread investor pessimism, it can evolve into a prolonged bear market.
Also Read: What Does It Mean To Buy The Dip?
Unchartered territory
It’s safe to say that investors have never before had to navigate a political environment as erratic as has been the case since President Trump took office for a second term only 7 weeks ago. Tarifs are announced and rescinded from one day to the next. Neighboring countries are threatened to be annexed. And millions of public servants are given the boot from one day to the next.
Historically, periods of high uncertainty have not been good for stock markets. Investors work with facts. Without these facts, they cannot price assets, compute risks and project business prospects. Those investors that have the choice will move to and stay on the sidelines until they are once again comfortable with the conditions to make sound calculations.
Frequently Asked Questions
How do I know when to go back into the market after a stock market correction?
A good time to re-enter the market after a stock market correction is when valuation metrics, such as the price-to-earnings (P/E) ratio, revert to and even fall below historical averages. Experienced investors will also look for signs of stabilization in earnings, economic recovery, and improving investor sentiment. While timing the exact bottom is difficult, historically, markets tend to recover as valuations normalize, making a gradual re-entry strategy a prudent approach.
How long does a stock market correction last on average?
Stock market corrections have historically lasted an average of four months. However, the duration can vary; for example, since 1987, corrections have resolved in about five months on average.
Can I beat the market by timing my entry during market corrections?
Timing the market is a challenging endeavor, as predicting the exact bottom is difficult, even for experienced investors. While buying at discounted prices clearly is desirably, investors run the risk of missing sudden rebounds. Historical data suggests that markets tend to recover quickly after corrections, and missing just a few of the best-performing days can significantly reduce returns. Instead of trying to perfectly time entries, a dollar-cost averaging (DCA) strategy—gradually investing over time—can help reduce risk and improve long-term performance.