The coronavirus has brought one of the worst scares to the stock markets since the Great Depression. There’s no doubt about it. Some stocks have hit a rock bottom and have made even the 2008 Financial Crisis look like a small blip in the charts. But at the end of the day, and when considering the bigger picture, this market crash was simply another bout of market volatility.
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Q2 2020 hedge fund letters, conferences and more
And market volatility happens all the time.
“For most of the last century,” Seth Klarman noted in his second-quarter letter to Baupost’s investors, “a reasonable approach to assessing a company’s future prospects was to expect mean reversion.” He went on to explain that fluctuations in business performance were largely cyclical, and investors could profit from this buying low and selling high. Also Read More
The question is, how to navigate through it? Well, it’s all about knowing how to stand strong through the uncertainty and to ultimately make the most of the opportunity. Because hugely volatile markets certainly shouldn’t be feared. In fact, clever investors know these moments can often present the greatest opportunity.
Volatile markets are also great learning hurdles for all investors to grow from, whether you consider yourself an expert or beginner.
Reacting To Market Volatility
Your first question is probably along the lines of – how can we establish some certainty by predicting which direction the market will go next?
The simple answer is, you can’t. Time has shown that not even the very best financial advisers can consistently predict market volatility.
That means, us as investors can only prepare how to react to substantial volatility and protect themselves from the whipsaw effect. Knowing what kind of strategy you may implement when a big crash does occur, will hopefully reduce some of the stress investors suffer from when not knowing what to do. Of course, this ‘strategy’ should not be set in stone but rather be reactive to the situation.
In a large sell-off senario, you have 3 options;
- Sell to recoup your losses.
- Hold out the storm.
- Buy more when you think it’s at rock bottom.
Statistically, it’s usually the investors that find the courage to stick to their long-term plans that are rewarded as the markets bounce back.
Market Recovery Is Guaranteed
The first thing you need to know is that a market recovery will always follow large amounts of volatility as the markets work to even themselves out. It’s science. It may take months or even years for the stock market to bounce back fully, but it always does.
With that in mind, here are three reassuring facts about market recoveries:
- Recoveries have been much longer and stronger than downturns.
Huge market dips are historically much less impactful compared to the long-term power of bull markets. Statistically, the average downturn in the US (since 1950) has lasted 14 months, whereas the average bull market has been 5x longer.
- After larger declines, markets have recovered quickly.
Historically, stocks have recovered more sharply following the steepest downturns, these returns are also stronger on average. The first year after the 5 steepest downturns over the last 90 years averaged a 71% return.
- Some of the world’s most innovative companies were born in market recoveries.
To name just a few, these companies were McDonald’s in the post WW2 1948, Walmart in the flash crash of 1962, as well as Microsoft and Starbucks in the stagflation era of the 1970s. Some more recent companies include WhatsApp, AirBnb and Uber that were born as a result of the 2008 financial crisis.
Good businesses always find a way to survive when times are tough. In fact, those that can adapt to difficult conditions often become much stronger in the long run and make more attractive investment opportunities.
So, now that we know a market recovery is guaranteed, what shouldn’t we do?
Three Key Pitfalls To Avoid
Here are three key mistakes or pitfalls investors should avoid when navigating through market volatility.
- Cash is not king – stay fully invested.
A very useful phrase that comes to mind is, “it’s time, not timing.” Taking your money out to mitigate losses may mean if you don’t get back at exactly the right time, you can’t capture the full benefit of a recovery. In this scenario, you may miss more ‘good days’ than avoid ‘bad days’ which will significantly hurt your long-term results.
Moreover, it’s actually more harmful to keep some cash assets on the side as low-interest rate environments mean return on cash is close to zero. This is a total loss of market return and opportunity.
Essentially, hoarding cash means risk losing on both ends by missing the market rally before the crash and then losing out when the markets swiftly return.
- Stop listening to negative headlines.
There will always be a reason not to invest at a specific time. Many well-known investors have commented that great opportunities come when the majority are feeling pessimistic. Going against the grain can take considerable willpower but often pays off.
- Don’t focus too much on the downturns.
Extend your time horizons, so you don’t get too caught up in the individual days. As mentioned, downturns don’t last forever and a market recovery is almost always guaranteed. Maintaining long term perspectives can help keep investors stay focused on the goals that matter most.
Uncertainty will never be a new concept and that means that while high market volatility can be extremely stressful, they are still something that investors can carefully prepare for. Take full advantage of the opportunities presented to you in downturns to reap the full benefits of the market recovery.