Market Corrections Compared to a Bear Market

A bear market is a prolonged period in which investment prices fall, accompanied by widespread pessimism.

If the period of falling stock prices is short and immediately follows a period of rising stock prices, it is referred to as a correction.

Bear markets usually occur when the economy is in a recession and unemployment is rising, as was the case during the global financial crisis in late 2008, or even when inflation is rising quickly as in the late 1980's to early 1990's. Conversely, in late 2006 Australia experienced a mild but healthy market correction  phase even despite it enjoying low levels of unemployment, no hint of a recession while inflation was still within the normal bounds established by the Reserve Bank of Australia (see inflation below). .

Bear Trap

This refers to the situation that occurs when a bear market reverses its trend while bearish investors who thought the decline would continue sell short. The bears are eventually forced to buy at a higher price to cover their short position when the decline doesn't occur. Sharp short corrections are fertile grounds for a bear trap on any number of equities and indices around the globe.

Inflation

The overall general upward price movement of goods and services in an economy, usually as measured by the Consumer Price Index. Over time, as the cost of goods and services increase, the value of a dollar is going to fall because the consumer won't be able to purchase as much with that dollar as they previously could. While the annual rate of inflation has fluctuated greatly over the last half century, ranging from nearly zero inflation to 18% inflation, since the mid 1990's, the Reserve Bank of Australia (RBA) actively tries to maintain a specific rate of inflation, which is usually 2% to 3%.

Market Correction

For the active investor, a correction is a beautiful thing, big or small. Theoretically or technically, corrections adjust equity prices to the value the market is prepared to pay for it; often referred to technically as support levels. In reality, it's much easier than that. Prices go down because of speculator reactions to expectations of news, speculator reactions to actual news, and investor profit taking. The two former reasons are more potent than ever before because there is more "self directed" money out there than ever before. And therein lies the core of correctional beauty! In Australia, large superannuation fund holders or the large mutual fund holders rarely take profits and accept the losses. For the self-aware equity investor, this opens up opportunities.

Corrections of all types will vary in depth and duration, and both characteristics are clearly visible only in institutional grade rear-view mirrors. As mentioned above, most corrections are difficult to take advantage of with Mutual Funds. But amid all of this uncertainty, there is one indisputable fact: there has never been a correction that has not succumbed to the next rally... its more popular flip side. So if the investor's opinion is that the Australian market is in a temporary and healthy correction and they believe the market has been temporarily oversold, cash is king.