Chart 1 Source: Bloomberg, iFAST Compilations

Maybe, or maybe not.

It’s what a lot of experts are saying, and it’s what some of us who work at FSM believed will happen. So we liquidated a part of our portfolios and kept some cash, some of us as early as June 2009, and we waited for the correction to come so that we would have some cash to buy in when share prices fell.

But the correction hasn’t come, not in a big way anyway. Meanwhile some of us are looking at the investments that we sold off, and we realize that if we had stayed invested, we could have made between 10% to 30% more.

At FSM, we have written many articles to say that it is a fool’s game to try and time the market, but in our “cleverness” for our personal portfolios, we became these very fools ourselves.

Here are 3 reasons why we should not be waiting for a major correction and why it may not come.

1. Economic and earnings numbers are improving all the time.

This is the number 1 reason why there may not be a major sell off. The economic and earnings numbers keep surprising on the upside and so investors are afraid that if they sell, they will miss a major run up in stocks.

Whilst it is true that some stocks may have run ahead of fundamentals, the reality is that as long as the fundamentals keep improving, existing holders of stocks are unlikely to sell. Rather, they are likely to keep holding the stocks and wait for the fundamentals to catch up. This removes many sellers from the market.

Without big sellers, and with more and more people convinced of the economic recovery everyday, demand for stocks increases, and share prices go up. At the very least, they stay flat, waiting for the fundamentals to catch up.

2. A lot of people are holding cash in anticipation of a correction.

When everybody expects a correction, there will be none. When no one expects a correction, it will come.

This is because with widespread expectation that a correction is coming, it is likely that a lot of people are holding cash. And they are buying in whenever there is some price weakness, thereby supporting the market and preventing a major correction from happening.

It is when no one expects a major correction to come, when most people are fully committed to the market that there is less support in buying. That is when the market becomes susceptible to selling.

3. The correction may come but it’s irrelevant

Ask yourself this honestly: What are you trying to achieve by waiting for a correction? Is it to make 10% more, 15% more?

If you believe that an economic recovery is underway, and that we will see an up-cycle in the market, trying to optimize your portfolio by that 10% or 15% may mean very little. What’s worse is that in trying to optimize that 10% to 15%, you miss out on a lot more. That is what some of us who have sold off our portfolios in anticipation of a correction have experienced.

The market could be choppy in the short term, it usually is. But if we have a strong target for the market over the next two to three years, we should ignore the short term volatility and just invest for that medium term goal.

Conclusion

Maybe you still don’t believe that the economic recovery is happening. Or maybe you are still paralyzed by fear at all the potential pitfalls that “experts” say can happen down the road. If so, you should stay out of the market altogether and keep your money in the fixed deposit. You are not suited to investing in the equity markets.

But if you are trying to learn to invest in the equity markets, know this important fact: the equity markets do not wait for things to be hunky-dory before it turns positive. The equity markets are a leading indicator of the economy: It turns down before the economy does, and it turns up before the economy does.

The best time to buy is when prices are low. But how do prices get low? It gets low when there is fear in the market, and people sell off. Prices wouldn’t go down when there is no fear.

So the good news is that there is still some fear in the market right now, (not like in March 09, when there was maximum fear and you could have made a lot more money if you plunged in then), but there is still fear, and that likely means that there is still some good value to be found.

If you are the type that waits for strong economic numbers to emerge before you plunge in, you are likely to be the last bastion of buyers into the markets. Fear would have evaporated, and everyone would be feeling good.

That’s the real time to worry about a correction.

Q&A

Q1: What evidence is there that markets are leading indicators of the economy?

A1: Please refer to chart 1.

Q2. The past half a year's bullish data could be due to the magic of the stimulus money at work, and for the coming months, with data showing that the economy has not been improved, things might turn ugly. Please comment.

A2: Put yourself in the shoes of the governments who have poured a lot of money into stimulus. If the stimulus is insufficient to get the economy back on track, what would you do? Would you say “too bad” and sit on your hands? Or would you introduce another stimulus? What would your voters expect you to do?

The recent months’ data have surprises both on the upside and the downside. Month-to-month data tends to be very choppy. Things are not unanimously good. If they are, markets would be a lot higher than they are now. The economy is still working out its issues, but it is certainly in recovery mode as far as GDP data goes.

We are not saying that the economy is recovering in a straight line up. We are challenging you to think about your feelings about a possible correction. Do you believe that in three years time the global economy would have worked out all its current issues and be on growth mode again? If so, you should be investing for that eventuality, and not try and catch possible short term fluctuations. If you do, like some of us did, you could find that it is very costly in terms of lost returns.

We do not mean that you should invest 100% of your money, especially if you are cautious of a correction. But certainly you should not be 0% in the market. It’s time to start getting in and not let the “possible” correction be the reason that keeps you out.

Q3: There is still widespread unemployment in the U.S.

A3: Put yourself in the shoes of the bosses that have retrenched many employees in Jan-Mar this year, just 6 months ago, and who have paid out huge amounts of retrenchment payments. If your business is showing some slight improvements now, would you be hiring? No. You would still be cautious. You would rather get everyone to work harder than hire. You will probably have more confidence in hiring some time in the middle of 2010, or even 2011, when you have better numbers to show. You might be operating at full capacity, when everyone cannot “work harder” anymore, and you would need to hire again to expand.

That is why employment is always a lagging indicator.