Equity markets around the world are in a freefall. The volatility in capital markets has risen to record highs as a result of two key market disruptions: the COVID-19 pandemic and the energy market turbulence. These are trying times for any investor. It’s safe to say that even the best investors out there have been affected by this market crash, including the likes of Warren Buffett and Seth Klarman. As value investors, a few key strategies and concepts need to be mastered to survive this market crash. The subject of this analysis is to highlight those to investors.
Learning from the history books
The best way for an investor to remain objective is to look at historical market declines to assess how equity markets have recovered. Because the current market decline was triggered by the outbreak of COVID-19, the most plausible thing to do is to analyze whether global equity markets have recovered from previous pandemics and determine how long it could take to stage a recovery.
An investor might be surprised to know that world equity markets have comeback strong following a pandemic. As illustrated in the below chart, the recovery has often been much larger in magnitude in comparison to the temporary decline.
The novel coronavirus is spreading at an alarming rate, but there’s hope for investors. As evident from the above chart, the impact of previous pandemics/epidemics has been short-lived. In the current situation, China serves as the ultimate example. After a two-month-long lockdown, the country is slowly but surely beginning to get back on its feet. On March 27, the Wall Street Journal reported that traffic is building up close to the industrial areas of the country, which is a clear indication that business activities are resuming. If the United States and other western countries can follow the lead from China, the global economic growth will once again resume in a couple of months at best. This, in return, will help stock prices soar, the same way it has happened during past pandemics.
Based on this available data, the first lesson to learn as value investors is that the decline in stock prices will most likely be temporary.
The power of staying invested
The next lesson for value investors underpins an important strategy that could improve the performance of an investment portfolio by a significant amount. Whenever stocks are tumbling, the natural human tendency is to dispose of everything and run for shelter. However, empirical evidence suggests that this could be a very bad idea.
Fidelity compiled market data from January 1, 1980, to December 31, 2018, and came up with the below chart that highlights the impact of missing just a few days in the market.
As evident, missing just 5 days would have resulted in a significant reduction in the total return. If an investor has found a way to predict exactly when the markets would start moving higher, it makes sense to sell everything and wait for that day. However, there is no way to do this, and attempting to predict the lowest lows and highest highs would eventually result in an investor missing the best days of the market. This, in return, could lead to very dire circumstances.
As a value investor, the second lesson to learn is to stay invested no matter how hard it would be to make that decision.
Diversification is key
The importance of diversification cannot be emphasized enough. Despite many legendary investors, including Ray Dalio, highlighting the benefits associated with properly diversifying a portfolio, many investors remain oblivious. This can be a costly mistake. A classic example is the performance of gold during recessions.
On average, gold has provided much better returns to investors when the S&P 500 Index reported its biggest declines. Therefore, an investor with some exposure to gold would have been able to report better returns during recessions and market crashes.
Value investors who have a very high concentration on specific business sectors or industries need to consider diversifying their portfolios better to survive the upcoming recession and future market declines. The best way forward is to allocate funds across various business sectors, countries, and commodities. From an economic perspective, the target should be to reduce the correlation between the securities of a portfolio. This is the third lesson for value investors to survive a market crash, including the current one.
An unwavering focus on long-term prospects is required from investors
Short-termism could lead investors to make mistakes. For instance, the travel and tourism sector is getting hammered at present. But, this sector is likely to recover very soon because of the growing middle-income society in Asia, expected economic growth in emerging countries, the growth of the gig economy which enables professionals to travel more often than they did in the past, and the household disposable income growth in developed countries. All these developments will act as catalysts for this industry to grow exponentially in the next decade. However, in the short term, the outlook is very different. Global travel activities will bottom out in the next couple of months and companies such as Booking Holdings, Trip.com, and Expedia will experience a severe decline in the demand for their products and services. If an investor can be bold enough to ignore the noise in the market, he would be able to hunt for bargains in this sector. This could lead to stellar returns in the future. The same thing happened in the years that followed the dotcom bubble and the financial crisis as well.
The fourth lesson for a value investor is to be bold and focus on the long-term prospects of companies and the economy rather than going with the tide and analyzing the short-term impact of the COVID-19 pandemic.
Takeaway: Learn from the best
The best investors in the world, including Warren Buffett, Carl Icahn, Ray Dalio, Seth Klarman, and Bill Ackman have all started to make the most of this opportunity to invest in attractive opportunities. Value investors should follow this lead and look for bargains rather than dwelling on the significant decline of world equity markets. Doing this, in return, can help them realize very attractive returns in the future, the same way many legendary investors have done in the past.
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