What Does A Big Market Correction Actually Look Like?

by: Regarded Solutions

Well, May is upon us and the old market axiom of "sell in May, and go away", can still be heard by the gloom and doom crowd who love to strike fear in the hearts of weaker investors who cannot stomach a market decline.

Fear and greed will always wreck havoc on investor portfolios if they over-react, or use emotions to make investment decisions for them, rather than facts, fundamentals, and logic. If nothing has changed with a company's fundamentals, then a drop in price of the shares offers opportunities for investors who can sniff out bargains. That being said, there are probably many folks who only have an apocalyptic view of market corrections in their head.

It is quite important to remove emotion from the decision-making process, and market pullbacks really do play tricks with investors thought processes. We always discuss this, but it might be an even better idea to illustrate what the ramifications might actually look like. If we use the Team Alpha Retirement Portfolio as a tool to actually show what several market pullbacks might look like for this particular portfolio.

The Team Alpha portfolio consists of Ford (NYSE:F) Chevron (NYSE:CVX) Apple (NASDAQ:AAPL), McDonald's (NYSE:MCD), Exxon Mobil (NYSE:XOM), Johnson & Johnson (NYSE:JNJ), AT&T (NYSE:T), General Electric (NYSE:GE), BlackRock Kelso Capital (NASDAQ:BKCC), KKR Financial (KFN), Procter & Gamble (NYSE:PG), CSX Corp. (NYSE:CSX), Realty Income (NYSE:O), Coca-Cola (NYSE:KO), Annaly Capital (NYSE:NLY), Cisco (NASDAQ:CSCO), Bristol-Myers Squibb (NYSE:BMY), Healthcare Select Sector SPDR (NYSEARCA:XLV), and Wells Fargo (NYSE:WFC).

Three Main Market Pullbacks That Strike Fear In The Hearts Of Mere Mortals

Remember, this article is hypothetical in nature but can be quite real if any of the scenarios actually occur. There are 3 main pullbacks that can affect investors emotions:

  • A market correction; usually a wide range of stock price drops of anywhere between 7-15%. No major fundamental reasons, but many investors take profits, or sell positions to seek other sectors and this phase is actually healthy for a secular bull market.
  • A bear market; an overall market drop of roughly 20% accompanied by several quarters of declining corporate growth in earnings and revenues. This scenario will also be confirmed with negative GDP growth for several consecutive months indicating a potential recession.
  • A full blown market retreat; we have heard about this happening any day now, and actually faced the situation back in the 2008-2009 market collapse. The entire markets drop by 30, 40 or even 50% largely due to a systemic problem that causes panic and a rush to exit the markets at just about any cost. Sometimes, investors never come back, and some folks actually get hurt at the worst possible times without hopes of ever recovering.

Let me toss up the last Team Alpha update chart to begin our little lesson:

Stock #Shares 4/27/2013 TotValue Orig. Price
XOM 100 88/shr 8800 75
JNJ 100 85/shr 8500 62
T 250 37/shr 9250 27
GE 500 22/shr 11000 15
BKCC 600 10/shr 6000 10
AAPL 20 417/shr 8340 436
PG 100 77/shr 7700 61
KO 100 42/shr 4200 34
XLV 200 48/shr 9600 39
WFC 100 38/shr 3800 37
O 200 50/shr 10000 32
KFN 600 11/shr 6600 10
NLY 200 16/shr 3200 14
CSCO 400 21/shr 8400 18
CVX 50 120/shr 6000 116
BMY 175 40/shr 7000 32
MCD 100 101/shr 10100 86
CSX 200 24/shr 4800 19
F 300 14/shr 4200 13
Cash Rsvs x x 3247
Tot Value x x 140737

It looks pretty darn good right now and carries a dividend yield on cost of 4.96% for a solid income flow, but what would it look like if the market "corrects"?

Stock #Shares 4/27/2013 TotValue
Cash Rsvs x x 3247
Tot Value x x 125937

The "mini" chart above reflects a market correction of 10% across the board. As you can see, the portfolio value is still nearly 26% higher than when it began with $100k. Some investors will flee but most will take an opportunity to see if there are some great bargains that can be picked up, to add more shares to the core holdings.

Keep in mind, that the dividend yield on cost is still 4.96% and the income received has not changed.

Stock #Shares 4/27/2013 TotValue
Cash Rsvs x x 3247
Tot Value x x 112589

As you can see from the "mini" chart above, the portfolio has dropped by 20% and is in bear market mode. Earnings and revenue contractions has taken its toll on the economy, and if the GDP is negative for several consecutive months, then the Government will announce that we are in a recession.

At this phase, investors begin to feel the effects of fear, and are wondering why they did not take profits sooner, or if they should now just get rid of everything to hang on to what they now have.

Remember the bottom line here; the yield on cost will more than likely still be 4.96%, and not one penny in income flow will be lost....unless you sell out! Also, please take note that the overall portfolio value is still 12% higher than when we began, due in large part to active management (locking in some profits) in the previous months, and the dividends.

Successful investors already have their shopping lists, and are ready to pounce.

Stock #Shares 4/27/2013 TotValue
Cash Rsvs x x 3247
Tot Value x x 70369

Here it is; market capitulation. This "mini" chart shows the apocalyptic drop of 50% that some of those fear mongering newsletters you receive in your email have predicted. For a price of course, they will share their "secrets" on how to avoid this scenario and save your portfolio. It usually has to do with buying lots of gold, but that is another story.

The facts, as you can see, tell a different story. Yes, the portfolio has given up all gains and is now down by 29% (having nice increases softens the blow from a 50% retreat) and fear has taken over many investors minds. Blood in the street and rushing for the exits has exacerbated the decline to improbable levels. Of course it CAN happen, but it is far from likely.

Keep in mind one essential fact; the dividend yield on cost will probably still be 4.96%. Not a cent of income will be lost, even in the face of a worst case scenario. Dividends can be cut or eliminated of course, but that is not the norm. If it does, perhaps the yield on cost could dip by .50% or so. Nothing apocalyptic about that anyway.

Are These Scenarios The End Of Life As We Know It?

Some doomsday prognosticators who also happen to be prolific marketers and self centered, money hungry opportunists, will offer free video presentations, newsletter teasers, and email alerts that work on the ultimate portfolio and wealth devastation; FEAR. Plenty of folks will fork over a ton of money to these people in hopes of getting the "answers" (after the teasers naturally) to avoid doom.

Of course, the folks selling this snake oil, will profit from many investors fear. My question to all of them is this; if things are going to fall apart, why not go on TV and spend your marketing dollars on saving EVERYONE rather than selling your "secrets" to profit form human misery?

I never expect an answer, and never get one, but let me tell you MY secrets, for free, right here.

  • Save as much money as you can, and then save some more.
  • Keep 5 years of cash on hand to pay all essential bills; food, shelter, clothing, health.
  • Eliminate all debt, including a mortgage.
  • Spend less than you have coming in, forever.

Maybe these "secrets" are not worth more than free, but by following the guidelines I just noted, YOU will be in a position to weather any financial storm, plus you will also have the opportunity to buy some extraordinary stocks at ridiculously cheap prices.

  • When others are selling hand over fist, seek out the stocks you want to buy hand over fist.
  • Buy low, sell high....never fails.
  • There are 2 sides to every trade.....those who are selling and those who are buying. In irrational times such as a market capitulation, I want to be the buyer not the seller.
  • One final word, the income derived from being a dividend income investor, will barely budge. You are in better shape than you realize.

Disclaimer: The opinions of the author is not a recommendation to either buy or sell any security. Please do your own research prior to making any investment decisions.

Disclosure: I am long AAPL, BKCC, BMY, CSCO, CSX, CVX, F, GE, JNJ, KFN, KO, MCD, NLY, O, T, WFC, XLV, XOM. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.