Portfolio Management 101 > Portfolio Management

When the Stock Market Correction Comes, How Bad Can it Be?

What does a market correction look like?

Let me first start by saying I am long-term bullish on equities. But after witnessing a record high Dow that exceeded 17000 and an S&P 500 index on the cusp of breaking 2000, I started wondering how much further this market can climb before it ‘corrects’, as the industry terms a sharp decline after a seemingly continuous ascent—as if the current market value is ‘incorrect’.

We know why it happens—the correction that is. Investors may be taking profits, rebalancing, or just simply be nervous of the subsequent crash after a trancelike high.

There are many more economists and analysts that think the correction is imminent than there was just a few months ago. In my opinion there isn’t a question as to whether the correction will come, but rather, when will it finally appear and how bad will it be?

At PM101, we invest based on fundamentals, but it doesn’t hurt to understand the technicals of the market or a particular investment. And while I’ll disclose that we are not experts here, we have become quite skilled at using technical analysis to complement our fundamental work.

So when do we think the correction will happen and how bad will it be? Well, it’s quite possible we may already be in the correction, even though we don’t think that is necessarily the case. But if the market is going to be correcting soon, we could see two possible scenarios play out. There seems to be some support at around 1950, shown by the top horizontal line on the top right of the chart below. The S&P could very well reach that level and bounce, but that level isn’t low enough to be termed a correction.

The second horizontal line shows another support level at around 1930, which coincides with the 50-day moving average. This looks like an important level. If the index breaks that level, we may very well be in the long-awaited correction.

S&P 500 Chart

If the S&P 500 index breaks below 1930, we may see the index decline all the way down to around 1860. The chart below highlights the next level of support at these levels. A decline to 1860 would result in a 6% decline from the 1985 high reached earlier this month. If this is the extent of the correction, we should consider ourselves lucky.

S&P 500 Chart

We’ve seen these levels of pullback before, and it is not the correction that you read about in the media. The correction talked about in the media is much deeper and can be scarier than just a 6% decline. The chart below shows two more support levels at 1810 and 1760. If the market reaches 1760, we can officially (as proclaimed by PM101) consider the market to be corrected. These levels would result in a decline of over 12% from the S&P high and would probably ignite new buying interest.

S&P 500 Correction Chart

However, a word of caution—a 12% decline in the market may spook investors to dump shares for fear of the market entering a bear market. If this were to happen and the market breaks through the 1760 level, it could drop all the way down to 1650!!! That’s a scary thought indeed.

In our humble opinion, we think there is a bit more upside to the market before we see the 10%+ correction that is anticipated. That being said, we are cautious that the correction may come sooner rather than later.







Active vs. Passive Investing

Source: http://www.urbandepartures.com/wp-content/uploads/2013/12/ActivePassive.png

Definition of active versus passive management

The difference between active and passive management is quite simple on the surface. Active management is just what it says it is: the active management of your portfolio by choosing investments on a continual basis, including when to buy and when to sell. It may include overweighting certain stocks or sectors while underweighting or avoiding others. And while individual stock selection is considered active management, so is choosing fund managers that invest in individual securities. Throughout this article I will refer to both individual stock selection and mutual fund manager selection as active management.

Passive management is not necessarily the opposite of active management, but rather, a strategy of investing in an index or sector, through a passive exchange traded fund (ETF) that is representative of a market. While this concept has evolved due to the proliferation of ETF’s focused on narrow segments of the market, the concept remains the same. For example, the iShares S&P 500 Index ETF (SPY) invests in all of the stocks included in the S&P 500 in the same proportions that those stocks represent the index. The iShares S&P Global Technology Sector ETF is also a passive investment, but is more focused on the technology sector specifically.

Fantasy Football Investing

Fantasy Football excuses

As the NFL regular season comes to an end, the Fantasy Football season is fast approaching its championship week. Since some NFL teams do not make the playoffs, the fantasy season must come to an end while all players are still participating. Usually by the last game of the NFL season, Fantasy Football owners around the world have collected their winnings and established bragging rights for the next year.  

While watching my closest friends and family participating in this ever more popular activity, I can’t help but notice the similarities of fantasy football coaching to investing in a diversified portfolio of stocks and bonds.