When Will the Market "Correct"?

07/26/2017 11:17 am ET

The market seems to reach new record highs every day, lulling investors into complacency. So far in 2017, there have been 27 new market closing highs. Every previous warning about market valuations has been followed by a new buying surge. The great fear now is being out of the market, not being fully invested.

But when “everyone” is “in,” everyone has a vested interest in believing the markets will move higher. And that consensus can be dangerous.

If you’re a stock market investor, you have to decide whether to take some of your profits off the table at this point. Selling is a decision that has consistently proved wrong in the current bull market. As I write this, the Dow Jones Industrial Average is up more than 3,200 points since the election last November — a gain of 17 percent!

When you evaluate your exposure to the stock market, it’s important to do so logically — and with the knowledge that absolutely no one, even those with the best track records, can give you any guarantees about the future. Here’s what to consider:

Are you worried about the market, or the economy? The two are not necessarily the same, nor do they always move in synch. We are in the ninth year of an economic recovery, already one of the longest stretches of economic growth in modern times. Only the 10-year recovery that started in 1991 has had a longer duration, a record that is likely to be broken by our current economy. The average duration of recoveries since the 1950s is 5.7 years.

On the other hand, the growth in the current long recovery period has been far below par. The economic recovery that started in 1991 produced 52 percent total growth before it ended. The average growth in a modern recovery is 26 percent. But so far, the current recovery has produced only 17 percent total growth, according to the WSJ Daily Shot newsletter.

It’s hard to justify this great bull market based on economic growth — or even on hopes of economic growth coming in the future from the Republican agenda of tax cuts and infrastructure spending. Those policies now seem far less likely to be enacted than just six months ago. So don’t tie your stock market analysis strictly to headlines about the economy.

What’s your current risk tolerance? Know your panic level; it may have changed in the past nine years. Now you likely have profits to protect. You’re also a decade closer to retirement and will have less time to make up for any losses in another market decline. Also, your life situation may have changed. You could be a lot closer to needing some of that money for college expenses or a wedding for your children, not to mention retirement or a second home.

Ask yourself: Would I feel worse if the market goes down and I lose money, or it if goes on to new highs without me after I set some money aside in a bank account that pays nothing? It’s a meaningful question that deserves consideration, both intellectually and emotionally.

Will it be a “correction” or a bear market that comes next? First, understand that it’s always “just a correction” until the market declines more than 10 percent. But even 10 percent can cause damage to your financial situation — and cause you to react in a panic.

Jim Stack of the InvesTech newsletter, who has had an excellent track record over nearly 40 years of market analysis, says in his July 21 issue, “The market is overdue for a pullback of 5 percent or more.” Stack notes that “on average, a 5 percent correction occurs every 7.2 months — and a 10 percent correction might be expected every 26.1 months.”

Stack points out that the current correction-less period of 17.2 months is by far the longest in this market cycle, which has actually seen 14 declines of greater than 5 percent since this bull market started in 2009. So you’ve made it this far — and now the rubber band is stretched to an extreme. Can you ride out the inevitable snapback?

One more thought from Jim Stack: A 5 percent market drawdown (correction) has occurred in every year of the current eight-year bull market, sometime in the months of May through October. You’ve survived so far. But we are overdue — and that’s The Savage Truth.

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