The Correction Came. Now What? | ETF Trends

By John Lunt, Lunt Capital

The fourth quarter of 2018 witnessed broad declines for most growth investments. The explosion in volatility coincided with increasing noise around policy, politics, and profits. Federal Reserve policy has adapted from a “long way from neutral” to a willingness to be “patient” and even change course “significantly if necessary.” The U.S. Government is in partial shutdown. Concerns persist about a slowdown in China and the impact of Brexit.  The trade dispute between the U.S. and China remains worrisome in the market’s eyes.  Those calling for a recession in the U.S. will be correct someday, but the data suggests that day is not imminent.  A resilient U.S. economy and consumer continue moving forward.

The list above shows plenty to worry about, but profit growth (while likely slowing) remains relatively strong. Our current view of recent market movements lands in the correction category (rather than something more sustained or ominous), but to paraphrase the famous quote from Keynes, if and when the facts change, we reserve the right to appropriately change our views and portfolios.

The market correction came. Many are asking—now what?  In August of 2017, I wrote an article with the title It’s Time to Review Your Market Correction Checklist.” I concluded the article with the following statement: “Whether a correction happens soon or is still years away, it is time to review your market correction checklist. In our opinion, the ideal investment allocation is the one that the advisor and client can live through.” It is ultimately unknown whether the correction has seen its low or if there are more declines ahead. However, each advisor and client should ask whether the portfolio and strategy they had at the beginning of Q4 2018 was one that they could live with during the subsequent noise, volatility, and decline. Did the portfolio and strategy do what you expected it to do? What can we learn from this experience?

In the August 2017 article, I posed seven questions, listed below. It is worth contemplating these questions in order to evaluate the effectiveness and appropriateness of allocations, strategies, and behavior during the correction.

  1. Is the investor’s time frame consistent with the portfolio allocation?
  2. How would the portfolio (and each allocation, strategy, and position) potentially respond to a 10% or 20% decline in U.S. Equities?
  3. Have you made specific allocation or strategy decisions that would lead you to expect the portfolio to decline more or less than the market?
  4. How will the active fund manager or the passive index rules respond during a market correction?
  5. How will the financial advisor respond during a market correction?
  6. Is each position the right size within the portfolio?
  7. How will the investor or client respond during a market correction?

 You had the questions before the test. The correction has given you some answers. Did your answers turn out to be correct? There is some dispute whether Mark Twain actually uttered this quote, but it conveys a powerful point nonetheless: “It ain’t what you don’t know that gets you in trouble. It’s what you know for sure that just ain’t so.”  Did the correction “correct” some of your market and portfolio assumptions?