What I learned about surviving sharemarket corrections

As stated in the previous chapter, sharemarket corrections can happen very quickly and often when market participants least expect them, and as such it is very difficult for any investor to be totally safeguarded from the impact on one’s portfolio from a correction.

Predicting the timing of when a correction will occur is generally impossible, although here are some common signals one should be aware of that can often signal that one is not too far away.

When investors are concerned about the direction of inflation or unsustainable government deficits, bond yields tend to rise as fixed interest investors demand a higher return. The Government bond yield in each country is used as the risk-free return from which all assets are often priced from – so that an increase in bond yields usually has a negative impact on the valuation of stocks. An increase in bond yields can also often force central banks to put up their short rates to appease bond investors and demonstrate that Central bankers are acting to bring inflation under control by trying to slow economic growth and inflation by tightening monetary policy;

While in Australia a higher gold price is often welcomed - as gold is one of Australia’s largest resource exports and there are many hundreds of gold-related companies listed on the ASX, many investors around the world often buy gold as it is seen as a safe haven – which often indicates that investors around the world are concerned about issues such as geopolitical tensions, the future inflationary outlook or overly large government deficits;

Another potential signal that a correction is due is often when one witnesses a period of high valuations and excessive speculation in the stockmarket. Thus, in 1987, the best-performing shares were speculative mining stocks, as well as companies run by entrepreneurs such as Alan Bond and Robert Holmes à Court, who used large amounts of debt to make aggressive acquisitions. During the tech boom, any tech-related stocks’ share prices – the vast majority of which were unprofitable – went to completely illogical levels. More recently in June 2026 we saw the listing of SpaceX on the Nasdaq with an initial valuation of US$1.75 trillion – this valuation could look excessive given the company is not yet profitable. Recently we also saw a company called Firmus – which currently does not make any money and is not forecast to do so for many years - look to list on the Australian sharemarket with a valuation of over $40 billion. Fortunately, sanity prevailed and the float was cancelled – demonstrating that the mood in the Australian sharemarket is much more cautious than some markets overseas, many of which have been totally enamoured and caught up in the current AI frenzy.

The patterns that repeat before a sharemarket correction

Despite these potential warning signals, there is still no reliable way to predict when a correction will occur.

As pointed out in the previous chapter, having lived through several serious corrections in my investment career, and each correction happened for various reasons, although they often do follow a similar pattern:

#1 The search for liquidity

In the early stages of a correction, there is often a sharp and quick sell off as many investors panic and seek liquidity and look to cut their exposure to the sharemarket. At this stage of the correction, generally every stock comes off fairly sharply in what I call a phase where ‘the good the bad and the ugly’ in the sharemarket all get heavily sold down;

#2 The bad and the ugly get sold off

Speculative stocks (what I call ‘the bad and the ugly’) generally get impacted the most, although good quality companies that have well established strong and resilient businesses like Coles and Brambles – can also get hit fairly hard as investors look to reduce their sharemarket exposure indiscriminately and often not taking into account the quality or valuation of the stocks they are selling;

#3 The return to quality

Eventually, and when the panic subsides, the sharemarket looks to find a bottom and in the ensuing months generally the good quality stocks – those with well established businesses, cashflows and have a long track record of dividends tend to recover first. On the other hand, once the correction has occurred most speculative stocks often tend to go to fractions of where they were trading at their peak as following a correction, the vast majority of investors are generally a lot more cautious and fully aware of the stockmarket risks and tend to stay away from stocks that were previously valued on “blue sky” with generally not much in the way of earnings.

How to keep your portfolio prepared

So, if corrections can happen without much warning and are a fact of life for long term sharemarket investors, how can investors be best prepared for such events?

First and foremost, it’s more important to focus on the quality of your portfolio rather than trying to time the market. To be a successful long-term investor in the sharemarket, one must always have a rule whereby the vast majority of your portfolio is invested in good quality, profitable and well-established companies that you understand.1 In my opinion any holdings in speculative companies should be kept to a minimum at all times because as mentioned earlier, speculative companies get absolutely smashed when corrections occur and most very rarely recover to anywhere near their previous levels.

As mentioned earlier the initial phase of each correction is generally indiscriminate, with the good, the bad and the speculative all being sold down as investors panic and many head for the exit. Only later does the quality of the stocks held determine the degree of recovery of one’s portfolio. I observed this in 1987, and I observed it again in 2001 and 2007. In the event of a correction, hold your nerve as even the highest quality stocks are impacted in the early stages of any correction as panic drives broad-based selling.

The reality is that share prices of every listed company are man-made creations and which vary from day to day based on the mood of the sharemarket and general investor perceptions about the future direction of the economy and companies’ earnings. A company’s underlying value does not change every day or from week to week, although the same cannot be said about a company’s share price!

I would also warn investors that apart from not getting carried away and sucked in by the noise during the boom times in the stockmarket to always maintain a very limited amount of speculative type of stocks (if any) in their portfolio and to also not be tempted to buy any speculative type stocks when markets start to correct.

Often after corrections have occurred, I will hear people say things like well “this stock was at $ 2 a few months ago (perhaps when the markets were much higher) and it is now trading at $ 1 cents so it must be good value / attractive”.

I would caution regarding using this sort of logic as when sharemarkets are on an upward path and investors are bullish, many speculative stocks that make zero earnings get priced on blue sky and can get to silly levels when investors’ mindset is all about the potential upside. However, during and after a serious sharemarket correction when the boom is over, the vast majority of these types of stocks can be

out of favour for a very long time and often they will keep falling for a long time after the boom until they go to fractions of their prices during the boom times. So as opposed to where the share price is trading, I would strongly encourage investors to only focus on good quality companies and to look to judge whether a share price is attractive or not based on things such as the sustainability of the company’s earnings, the PE valuation, the quality of its business and its dividend yield of the company, as opposed to trying to judge whether a share price is attractive based on where the share price traded before, especially when market conditions have changed. 2

Thus, it’s always important to build a good quality portfolio of well diversified companies with recurring earnings such as sectors like supermarkets, healthcare companies and logistics companies and the like - companies in these sectors which are well established will be around for a long time yet and will continue to make profits and pay dividends for many years in the future. 3

With this in mind, it’s also important not to get too carried away when sharemarkets are rising and reaching new highs. Always stay focused on good-quality companies with a history of recurring earnings that have been, and are likely to continue to be, around for a long time.

In some ways, short term movements in share prices are a bit of a lottery – they go up and down with no one truly knowing where they will be next week or next month. Having said this, companies with good underlying earnings can have the potential to continue to support underlying dividends throughout all sharemarket fluctuations, and the long term trajectory of the stock price of a good quality company that is increasing its earnings will potentially trend upwards in the longer term. Quality companies that pay out a proportion of their earnings as dividends will most likely to continue to do so, even when their share prices fall because of a sharemarket correction - and dividend income from a good quality portfolio of shares can be a reliable component of investment returns and income during volatile periods.

Diversification is critical

It is important to be successful as a long term investor in the sharemarket, that you build a diversified portfolio of quality companies that you understand and have faith in and that you have assessed on their long term merits, as this will help you hold and be comfortable holding even if – for whatever reason - the stockmarket took a sharp, sudden and unexpected turn for the worse.

Investors who build their portfolios this way will not only find themselves in a stronger position than the speculators when corrections occur, but they will be well-positioned to add to their holdings at very good prices during a correction and at prices that were not available during the previous bull run.

Over my 4 decades of being a sharemarket investor, I learnt early on that patient, cautious investors have the ability to do very well investing over the long term in the sharemarket in good quality stocks, while the investors chasing quick short-term profits from the sharemarket can often end up a lot worse off.

*This information is general information only and does not constitute financial advice or a forecast

Education

Reflections on major sharemarket corrections

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