The Correct View of Corrections: Opinion

NEW YORK (TheStreet) -- Relief rallies feel pretty good, don't they? That's what the past four trading sessions have been. We are still a couple of percentage points below the recent peak but it feels like investors are breathing a collective sigh of relief that last month's correction never technically became a correction.

You call that a correction?

Up to a 10% decline can be called something like a pullback or a dip, but not a correction. A correction occurs whenever the stock market drops by 10% or more. When we get to a 20% decline, peak to trough, we are now in a "bear market." Is this information helpful at all? The answer is, "Not really." 

Were we in a bull market at the end of 2008? Nope -- to invest at that point would have been no different than flushing your money down the toilet. You would have been investing during a bear market! Anybody who has passed the Series 7 knows that is a bad idea. Yet, in hindsight it would have been one of the smartest things you could have done.

So we want to buy low and sell high, but the media would have you believe that we rarely want to buy during a correction, and absolutely never buy during a bear market. Make sense? Why is it so easy to buy a shirt or a box of cereal when it's clearly marked "sale" but so difficult when it's the stock of a company you'd like to own?

In reality, the best times to buy are during bear markets and the best times to sell are during bull markets. Trouble is, you can look and feel quite foolish doing the right thing. Keep in mind that there will be an element of "wrong" in every single one of your investment decisions -- you will never buy at the absolute bottom and never sell at the absolute top. Come to terms with that, accept that this is not an exact science.

One definition of the word "correction" is "punishment intended to rehabilitate or improve." Of course, this is not the definition pertaining to a stock market correction, but I find the inclusion of the word "improve" interesting.

The efficient market hypothesis tells us that the market is perfectly efficient -- that every security is priced exactly as it should be priced, given all publicly available information at any given moment. The market does not anticipate, it reacts, and as a result prices move -- sometimes dramatically.

A correction can be viewed as the market being punished so it can improve. I think this concept applies to each of us investors as well.

What were we hearing and reading about just one week ago? How the Federal Reserve's tapering and corresponding spike in interest rates worldwide would put all emerging markets in a headlock, driving up borrowing costs and destroying their purchasing power one by one, starting with Turkey.

Since then we have watched rates stabilize even lower than when tapering commenced on Dec. 18.

10 Year Treasury Rate Chart
10 Year Treasury Rate
data by YCharts


Pretty ironic considering here is what happened to rates last May when then-chairman Ben Bernanke alluded to tapering but the Fed kept its foot firmly on the gas:

10 Year Treasury Rate Chart
10 Year Treasury Rate
data by YCharts

R-A-L-L-Y Spells Relief

In addition, on Tuesday we heard that current Chairwoman Janet Yellen understands very well what is at stake in her role as Bernanke's successor, and we saw stock markets here and abroad rally convincingly on her testimony before a House committee. Perhaps most interesting is the fact that markets have rallied in direct correlation with their respective interest rate sensitivities.

Below you can see that emerging markets had a better day Tuesday than other international (Ex-US) markets, which in turn had a better day than the U.S. market.

VTI Chart
VTI
data by YCharts

Don't Get Mad, Get Back to Even

I would argue that it feels better for investors to recoup losses than it does when portfolios hit all-time highs. When you have fallen below your previous personal high watermark, a bit of anxiety sets in that doesn't quite relent until you "get back to where you were." Of course this is short-sighted and a little silly when you take a step back, but it's also just human nature. Nobody likes to give something away and get nothing in return except bad feelings.

There is something scary and uncertain about hitting an all-time high-partly because we have never been there before, and partly because headlines start to shift toward things like "Is the Bull Finally Running Out of Steam??" or "[Insert Annoyingly Cynical Pundit] Says the Bubble Is Getting Even Bubblier!"

So, despite the fact that what we experienced the first five weeks of the year was not technically a correction, was it enough to allow the markets and investors to improve their positions? Was last week the best buying opportunity we will see this year? How many people who were too afraid to buy "at the top" were still hesitant to buy last week for fear the pullback might become a correction?

One thing I can guarantee: There will be many more pullbacks, dips, corrections and crashes to come. My goal is not investing to avoid them but investing to get through them. Investing to avoid all potential downside is like wearing a parka year-round for fear that winter may come early this year.

At the time of publication the author had no position in any of the stocks mentioned.

This article represents the opinion of a contributor and not necessarily that of TheStreet or its editorial staff.

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