Investing strategies during market downturns
Downturns can bring investing strategy opportunities
IN A FEW WORDS
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Downturns can bring investing strategy opportunities
One of the most effective investing strategies is buying low and selling high. But it’s harder than it sounds to spot the opportunities and hold your nerve. For many the key is to invest regularly and not be tempted to sell when markets dip. The investing holy grail is buying low and selling high. While this investing strategy sounds easy in theory, it is surprisingly difficult to do in practice because it means buying when the world might look pretty bleak. How can investors manage their squeamishness to profit from stock market volatility?
The past two decades has seen three notable market sell-offs
The first was in the wake of the technology boom of the late 1990s, the second came amid the Global Financial Crisis (GFC) and the third as a result of the pandemic.
In each case, the turning point for markets came with little or no fanfare. Blink, and investors might have missed it.
The first turning point came in October 2002. Economic growth was not particularly strong and a US-led coalition was about to become embroiled in the first Iraq war. But the lofty valuations of the technology bubble had largely unwound and corporate earnings were improving. Nevertheless, few would have picked it as an obvious moment for markets to revive.
Similarly, the market bottomed out in February 2009, just five months after the Lehman Brothers bankruptcy and a long time before the outcome of the GFC was clear or the US economy recovered. US GDP dipped 2.5% over 2009, and its weakness was reflected in the majority of other economies. During the pandemic, the market’s weakest point was in March 2020, after which it started to recover. This was some time before the discovery of an effective vaccine or economies started to reopen.
The message from these moments is straightforward: markets tend to panic first and ask questions later. During times of extreme volatility, markets are not rational. This can create opportunities because it means good is thrown out with bad and investors can pick up assets more cheaply.
How to tell whether an asset with a falling price is an opportunity
Share prices can fall for different reasons: market confidence may have been dented by, say, geopolitical events, war, trade disputes or weakening global growth. Alternatively, it may be a problem specific to a sector: hotels during lockdown, for example, or supply chain problems for semiconductor companies. Finally, it may be a problem specific to that company – the departure of a well-respected management team, the weakness of a new product line or a company scandal.
If a company is simply caught up in a wider change in sentiment, this can be an opportunity. The Amazon share price fell 16% in the pandemic panic.
With hindsight, it was simply caught up in the wider market turmoil and its business was never likely to be affected by lockdowns. In the end, it benefited from a move to ecommerce and its share price doubled over the next six months.
A problem specific to the company can still represent an opportunity. Companies can move on from scandals, introduce stronger management teams and deal with supply problems. However, investors need to be reassured that the weakness is not fundamental to the business prospects and the company is taking it seriously.
Liquidity can also be a friend to volatility investing strategies. It will often dry up in smaller markets as volatility hits, meaning share prices are pushed below fair value. For example, during the pandemic, there were real fears over commercial property. Investment trusts focused on the sector were pushed to discounts of 40-50% to the net asset value of the underlying assets. There were undoubtedly problems, but the market had over-reacted. For brave investors, it would have been a good moment to buy in, benefiting from both the recovery in the asset values and the narrowing of the discount as liquidity improved.
Keeping a steady course is one way to profit from stock market volatility
It can take a steely nerve to find opportunities in difficult markets. Investors need to ignore the market noise and focus on the reality of a company’s prospects, while making sure they have some cash available in their portfolios to take advantage of opportunities as they arise.
A simpler solution is to invest regularly, buying whatever the market is doing. Sometimes prices will be higher and sometimes they’ll be lower, but it should largely even out over time. Avoiding the urge to sell when markets are falling is another good strategy as this is a sure way to achieve the opposite ends: selling at a low point and then buying back into the market once prices have recovered.
Financial markets are created by humans, who tend to panic, overreact or become wildly optimistic. This means that prices do not always reflect reality, bringing opportunities for investors who are willing to look beneath the surface and build a true picture. Fineco’s award-winning platform with access to 26 global markets and low, transparent pricing allows investors to take advantage of opportunities as they arise.
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