CNBC reports a “‘Cleansing Correction’ Will Likely Hit Stocks Within Weeks, Federated’s Phil Orlando warns.” But what is a cleansing correction, and what does it mean for investors?
Is a Cleansing Correction Good or Bad?
Orlando spoke with CNBC’s Trading Nation, the multimedia financial news program that shows investors and traders how to use the news of the day to their advantage.
“Federated Hermes is an investment manager headquartered in Pittsburgh, Pennsylvania, United States. Founded in 1955 and incorporated on October 18, 1957, the company manages $575.9 billion of customer assets, as of December 31, 2019”.
June is likely to be a turbulent time for investors; “cleansing correction” could cause a 10% decline within weeks, says Orlando.
“A cleansing correction washes out the weak hands, and it allows the strong hands that understand the economic cycle to participate in the next up leg,” he said.
What is “Cleansing Correction”?
A correction is defined as a fall of 10% or more in the price of a financial market, a security, or an asset from its most recent peak.
They can last for an indeterminate amount of time, days to months, or even years. However, corrections typically only last around three or four months.
How Can a Correction be Predicted?
Financiers and analysts can predict corrections which usually trigger from large-scale macroeconomic shifts, and for a variety of reasons. By comparing market indices, analysts can uncover patterns and similarities that signal a market correction is looming.
Although they can cause short-term damage, a correction adjusts overvalued asset prices, delivering buying opportunities, and producing a healthy fix.
For many investors, a correction is a blip on their investment journey because they plan for the long-term. The market will recover eventually, and so investors should not panic.
Orlando thinks the next series of “pretty brutal” data is likely to be the spark for the correction. He refers to the second-quarter corporate earnings and second-quarter GDP as the few “big fundamental things on the horizon.”
His forecast pertains to ‘momentum traders’ who buy and sell assets according to recent strengths of price movements. Their hope is that if there are enough buyers, this will force prices further.
“You’ve got some investors who are bearish by nature and got sucked into this 36% rally,” Orlando said.
“Many investors may very well take profits disproportionately in the areas that have worked,” Orlando said. “If the fundamentals remain strong, there is no reason not to continue riding those stocks higher looking over the next year or so.”
Technology and healthcare are likely to be vulnerable in the next few months because they have been outperforming recently.
What are the Pros and Cons of a Market Cleansing Correction?
- Generates buying prospects into high-value stocks
- Soothes over-inflated markets
- Can be alleviated by stop-loss/limit orders
- Can lead to panic, overselling
- Can turn into an extended decline
- Harms short-term investors, leveraged traders
How to Prepare Your Investments for a Correction
Stocks may perform well before a market correction, but specific assets often perform poorly during a period of correction because of the hostile market conditions.
Investors can set stop-limit or stop-loss orders to protect assets, but these need to be monitored regularly to check the validity and to mirror market conditions.
Look at historical correction data and try to plan appropriately. It is usually best for the longer-term investor to buy after a cleansing period but always seek financial advice if unsure.
Above all, don’t panic and make hasty decisions. Having discipline and patience, focussing on the long-term goal will be critical.
It remains to be seen if the market correction will turn into a full-blown bear market. These are somewhat infrequent, the last one being in 2009. According to Kiplinger, 8 Things to Know About Stock Market Corrections, since 1926, only eight bear markets have been recorded; the worst was during the Great Depression when stocks dropped over 83%.
What are your thoughts on the potentially forthcoming cleansing correction? Have you been through one before? If so, what advice can you impart to other investors? Please comment below.