We are finally getting some overdue weakness in the stock market. I say overdue, because we haven’t had a 10% correction since 2011.

Still, the S&P 500 at yesterday’s close of 1928.21 is only down 4.5% from its 52-week high of 2019.26. While no one knows what the future holds, some context can be helpful when pondering what may be in store for your portfolio.

Where We Stand

The bull market is five and a half years old and the S&P 500 has roughly tripled over that time. Some say it has all been due to the Fed, but earnings have also been on a tear since the bottom in March of 2009.

I don’t see signs of a recession on the near-term horizon for the economy. This would suggest that downside should be limited. That said, we can easily expect a 10-12% correction sometime soon (this may be it).

And with the age of the bull market, international economic weakness, the strong dollar, and the end of quantitative easing, a 20-30% cyclical bear market can’t be ruled out. But a 50% wipeout, while not being beyond the realm of possibility, would seem to be quite unlikely.

Jeff Saut, the chief strategist for Raymond James, sees a correction soon, but thinks we are in a secular (long-term) bull market like 1982-2000. If so, selloffs are long-term buying opportunities.

Take The Long View

If you are invested in equities, you have to take the long view. Have a good plan and an asset allocation that is appropriate for your goals and risk tolerance, but know that the price of good long-term returns in stocks is occasional near-term unpleasantness.

Unless the fundamentals of the businesses you are invested in have deteriorated, there is no reason to sell, and good reason to consider buying on price weakness.

“Real investment risk is measured not by the percent that a stock may decline in price in relation to the general market in a given period, but by the danger of a loss of quality and earnings power through economic changes or deterioration in management.” — Benjamin Graham

Retirees Need A Portfolio That Will Allow Them To Sleep At Night

If you are fully invested and a retiree or near-retiree, the prospect of a selloff is not very pleasant. Asset allocation and risk management are key. You need to create a portfolio you can live with in good times and bad without panic selling at the bottom.

“Ultimately, nothing should be more important to investors than the ability to sleep soundly at night.” — Seth Klarman

For Young People, A Selloff Is Good News

Jason Zweig quipped that he’d like to start the Benjamin Graham Financial Network, which would report selloffs as good news.

Particularly if you are a young person just starting out, downward volatility is your friend because you can buy cheap, and you will be shoveling money in and compounding your returns for decades to come.

Your emotions may suggest differently, but a selloff is good news for you as long as you have the fortitude to keep buying when stocks are going down. Remember that money you will need or want in the next 5 years has no business being in the stock market.

“If you are shopping for common stocks, choose them the way you would buy groceries, not the way you would buy perfume.” — Benjamin Graham

Emotion Is The Investor’s Biggest Enemy

Emotion is the investor’s chief enemy, because it makes us want to buy after stocks have gone up, and sell during and after a selloff. Leaning against your emotions is one of the most important parts of being a successful investor.

If you can’t do it yourself, a good adviser can be worth their weight in gold if they can talk you down off of the ledge and keep you from selling into a panic.

The time to prepare for a selloff is when the market is charging higher. The emotions are too punishing to think rationally to come up with a plan during a selloff.

“The real ‘perfect’ portfolio is whatever approach allows you to stick with your investment plan without completely abandoning your strategy at the worst possible times.” — Ben Carlson

Season of the Witch

October has a reputation as the month of crashes, and several famous ones have come during the month — 1929, 1987, 2008. However, it has better average performance than September, though this doesn’t help much if this year is one of the outliers.

But October is also the end of the traditionally weak 6 months beginning in May, and many times it is when a near-term bottom is made. And the upcoming 3rd year of the Presidential Cycle is also usually quite strong.

The Long Term Looks Bright

None of these positive seasonal tendencies are guarantees, but doom and gloom predictions should be ignored.

The advances ahead in technology in general, and biotechnology in particular, will likely be amazing. And as Jeff Saut has pointed out, the American Energy Revolution is like putting Saudi Arabia on top of America’s industrial might. These factors all seem very bullish long term.

Never lose faith in the ingenuity of the American people. This is what you are betting on in the stock market in the long term.

Keep one eye on valuation and another on risk management, and you will be fine. Make a good plan and stick with it through thick and thin.

See also:

Current Thoughts

Charlie Munger and The Miracle of Tax-Efficient Compounding

Barry Ritholtz Radio Interview with Jeff Saut

Judith Curry: Climate Scientist Sees Global Warming Statistical Meltdown

Buzzkill for Stoners