It has certainly been a volatile past few years on the stock markets. After the S&P 500 tanked some 33% in March 2020 after the pandemic hit, it more than doubled from the troughs of the COVID-19 bear market to almost 4,800 at the end of 2021. Then in 2022, the S&P 500 fell 19% as the technology bubble burst. So far this year it is up roughly 8% year to date, as of May 9, but many market analysts believe we could see yet another correction, which is defined as a market drop of at least 10%.
Here's what Wells Fargo's Chris Harvey said in a research note in April: "In our view, equity downside will be driven by worsening economic conditions, a function of: aggressive monetary policy; potential capital/liquidity issues catalyzed by the bank crisis; and a consumer that is increasingly reliant upon credit to sustain spending."
That would result in a 10% drop from the S&P 500's current levels through the end of the year, he projected.
Whether or not that actually happens is anyone's guess. But what investors can do is prepare for that possibility. Here are a few things to keep in mind.
Stay focused on the long term
While this may be a particularly volatile period for the markets, keep in mind that short-term fluctuations shouldn't materially alter your investment strategy. Presumably, if you are an avid reader of the Motley Fool, you do your research and select stocks and investments that are built for the long haul, with business models and attributes that allow them to weather the markets ups and downs and produce solid long-term returns.
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Also remember that bull markets historically last longer than bear markets and generate returns that significantly outpace any losses from a bear market or correction.
So, there is no need to panic or make any wholesale changes to your portfolio. However, it might be a good time to review your portfolio and make some tweaks on the margins, with an eye on a few things.
What to look for
It is always important to have a diversified portfolio, but it becomes even more essential during volatile markets. If your portfolio is heavily skewed toward a particular investment style, like growth stocks, or a sector, like technology, make sure you balance that out with investments that tend to perform differently in different market cycles.
In down markets, there are two types of investments that offer that type of balance. One of them is dividend stocks -- those that pay out consistent, high-yielding dividends. Dividends not only have the ability to generate income, but if you reinvest them in the fund, they contribute to the total return of the stock. In the bear market of the 1970s, dividends accounted for 71% of the total return of the S&P 500, according to research from Fidelity Investments.
The other is stocks with lower valuations. While many great technology and growth stocks saw their values come back down to earth last year, some are still overvalued. If there is another correction, it is more likely that the overvalued stocks will be the ones to take a bigger hit.
There are many different metrics to measure the valuation of a stock, but the most common are price-to-earnings (P/E) and price-to-sales (P/S) -- the latter is used more for growth stocks without a history of earnings. A bank stock, for example, is going to have a lower P/E ratio than a technology stock, for the most part, so there is no ideal P/E ratio -- it depends on the stock. But a red flag should go up if the P/E ratio (or P/S ratio) is well above a particular stock's historical range. If that's the case, it could be overvalued.
If you pay attention to diversity of holdings and portfolio balance, keep an eye on valuations, and don't panic -- your portfolio should be able to handle market volatility.
