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Market correction – how to weather market storms

As global stock markets continue to drop and US markets fall into correction territory, we take a look at how investors can weather market storms.

Important notes

This article isn’t personal advice. If you’re not sure whether an investment is right for you please seek advice. If you choose to invest the value of your investment will rise and fall, so you could get back less than you put in.

Global stock markets have taken a tumble at the start of 2022, with a sea of red across most major market indexes. In fact, January saw the worst weekly performance for global stocks since October 2020.

Continued fears around record-high levels of inflation and the threat of interest rate rises have spooked investors.

US markets felt the burden the most, technology shares in particular. The tech-heavy NASDAQ index – home to gargantuan names like Apple, Amazon and Microsoft – fell into market correction territory this month. It’s the 66th correction since the index was created in 1971.

While these market drops aren’t pretty to watch, we think it’s important for investors to hold their nerve in times of uncertainty. It can be the difference between investing success and failure over the long term.

With this in mind, we take a closer look at market corrections – what they are, why they happen and how investors should react.

This article isn’t personal advice. If you’re not sure what’s right for your circumstances, please seek financial advice.

What is a stock market correction?

A stock market correction is when the level of an index falls by 10% or more from its most recent peak.

Market corrections come in different shapes and sizes. Sometimes falls are evenly spread across global stock markets. Other times sell-offs are more focused on a particular country or sector. In most cases, the reasons behind the correction determine where the impact is felt the most.

What causes a market correction?

There isn’t always a rhyme or reason for sudden drops in markets.

However, corrections typically stem from a reaction to an economic event or shock that causes sentiment towards the market to change rapidly. It’s what makes guessing which way the market will go in the short term near impossible.

Valuations can also be a sign that a market correction might not be too far away. In periods of strong and sustained growth – like we’ve seen in recent years – certain investments, sectors or markets can become overvalued. This can cause investors to cash in on profits when the outlook for the economy and the companies they invest in start to look less encouraging.

Ultimately, a market correction happens when there are more investors heading for the exit than there are entering the market on a large scale. Here are some key factors that can spark this behaviour:

Inflation – rising inflation is typically bad news for the stock market and investors as increased costs for companies can eat into the bottom line. It also makes it harder to get a ‘real’ return – one that outpaces the level of inflation.

Interest rates – increases to interest rates can also send jitters across markets. Higher interest rates make the cost of borrowing money and servicing existing debt more expensive. Both bad news for companies that need to borrow money to fund future growth opportunities, or those with lots of debt.

How rising interest rates can impact the stock market

Political events – things like general elections, referendums and budget announcements can cause investors to shun certain countries for new investment. For example, lots of investors have ignored the UK since the referendum in 2016 down to uncertainty on how UK companies could prosper in a post-Brexit world.

Natural disasters – the Covid-19 crisis acted as an example of how shock events can impact markets. Back in March 2020, as global lockdowns were announced, stock markets around the world fell significantly as investors feared how companies would fare under such extreme restrictions.

How we think investors should react – keep calm and carry on

The key message for investors is to not panic.

Sometimes doing nothing is best. Selling your investments on the worst days in the market could mean you miss out on the best days.

Short and sharp falls in the value of your investments is, undoubtedly, uncomfortable to watch. But it’s important to resist the urge to make any reckless and irrational decisions based on emotion – it’s rarely a recipe for success.

If you’re new to investing, you might not have experienced a market correction before. The first one is probably the most nerve-wracking. However, once you’ve seen your investments drop in value and then hopefully recover, future market corrections can become less stressful.

Investing for the long term – that’s at least 5 to 10 years – and sitting tight through market ups and downs gives you the best chance at investing success.

Of course, nothing is guaranteed when investing. There’s a chance the value of your investments might not recover, and you could get back less than you invest.

More on market falls and comebacks

It’s easier said than done, topping up your investments after a recent market correction could help lower the average price paid for your investments over time.

It’s important to weigh up the risks with this approach though. It’s difficult to know where ‘the bottom’ of a market correction is, and prices could continue to fall back further into a bear market – where prices fall by 20% or more from its recent peak.

As always, any investments you buy should be based on your investment objectives, attitude to risk and there should be a specific need for that investment in your portfolio.

Diversification is key to softening the blow from any market falls. Holding a mix of investment types, like shares, bonds and commodities can help shelter your portfolio from the worst of the market falls.

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Important notes

This article isn’t personal advice. If you’re not sure whether an investment is right for you please seek advice. If you choose to invest the value of your investment will rise and fall, so you could get back less than you put in.

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