US market enters deeper into the correction phase: What should investors do now?

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The S&P 500 entered deeper into correction on Wednesday as it fell 1.8% to 4,225.5. The index is now nearly 12% down from its Jan. 3 record high. As per market experts, a correction is a fall of at least 10% but not more than 20% from a recent peak. So by definition, the US market has entered into a correction. Given the concerning geopolitical situation between Ukraine and Russia,, there are fears that the US may enter the bear phase (fall more than 20%) in the near-future.

What has caused the correction?

There are two main reasons for the current correction in the US market:

  1. The tension between Russia and Ukraine could lead to a full-blown war. The fear of war is keeping the investors on the edge. Historical data has shown war is never good for economies around the world. If the US imposes more sanctions on Russia, it will impact the US economy also.
  2. The second reason is the expectation around higher interest rate hikes by the Federal Reserve in the coming months.

Are corrections rare or frequent events?

  • The last time S&P 500 entered into a correction was on 27 February 2020, when the market was starting to fear the outbreak of the COVID pandemic.
  • The last correction, as mentioned above, happened two years back, and that is the average duration for corrections. Hence, on average the US market has seen corrections every two years.
  • Between March 2009 and February 2020, S&P 500 had five corrections - the primary reasons for these were interest rates, European debt crisis, and trade wars with China.
  • It is the 24th time in the last 50 years that the S&P 500 has fallen at least 10%.

What happens post the correction?

  • Since 1946, the S&P 500 has taken an average of 135 days to hit bottom and lost an average of 14% along the way.
  • On average, the index gains 0.7% one week following a correction but declines 0.4%, on average, about two weeks out. 
  • Thereafter, the market marches higher in the following three-week, one-month, six-month, and full-year periods.
  • Of the past 20 corrections that have occurred in the S&P 500, including those that have morphed into a bear market, the S&P 500 has ended higher 70% of the time.

S&P 500 after closing in correction territory
 

How much damage can the war cause?

  • Goldman Sachs, in its recent report, warned investors of a sharp sell-off in risky assets globally if the war happens between Ukraine and Russia. It said, "The S&P 500 is at risk for a 6.2% drop in a full-on crisis scenario if Russia invades Ukraine and global superpowers respond with retaliatory measures such as sanctions."
  • If further added that sell-offs would be more severe for the tech-heavy NASDAQ100 and the small-cap Russell 2000. It estimated a 9.6% and 10.2% fall in a worst-case scenario, respectively. 

How has the market behaved historically after geopolitical events? 

  • The table below from Truist Advisory Services shows that the S&P 500 was higher a year after major geopolitical events in nine of the 12 times, with an average gain of 8.6%. The table below summarises these events.

What should investors do?

  • As discussed above, such situations of geopolitics, wars and invasions has mostly had a fairly short term impact on the stock markets. Hence, investors should avoid panic selling when faced with volatility.
  •  Invest in equities in a staggered manner. 
  • Keep your SIP’s running. Stick to large caps and index stocks that are best suited to navigate the ongoing volatility
  • Invest only high-quality AAA-rated bonds as they have the least risk.
  • There is a significant tax advantage in holding a debt fund for more than 3 years. 
  • For a more than 3-year investment horizon, an investor should prefer short duration (duration < 3) fixed income instruments over a long duration. Stick to short duration funds and bonds, as yields are expected to remain volatile in the near future. 
  • Avoid lump sum allocation and adopt a more staggered approach over the next few months.
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