We are currently in the midst of the fastest ever bear market in history. We live in uncertain times. No one knows how long the COVID-19 outbreak will last and what is the depth of its near-term economic implications.
Across the globe, sporting events have been postponed, numerous gyms and schools are closed, and travel restrictions have been imposed. All of which will reduce expenditure and have a very real impact on corporate earnings and the economy.
Our foreign minister, Dr Vivian Balakrishnan, recently reminded everyone to be vigilant and that the economic implications would last at least a year.
Even the emergency rate cut by the Fed on Sunday to bring interest rates to 0%, and the announcement of US$700 billion in quantitative easing, failed to spark any enthusiasm in the stock market. The S&P 500 in the US closed with a 12% fall in the wee hours this morning. At home, the Straits Times Index was down 5.25% on 15 March 2020.
In these dark times, I thought it would be a good idea to outline my gameplan to survive this and future market downturns.
Only invest the money I don’t need for the next five years
Stocks are volatile. That’s a fact we can’t escape. This is not the first bear market and certainly not the last.
My blogging partner, Ser Jing, shared some interesting stock market facts in an earlier article. He wrote:
“Between 1928 and 2013, the S&P 500 had, on average, fallen by 10% once every 11 months; 20% every two years; 30% every decade; and 50% two to three times per century. So stocks have declined regularly. But over the same period, the S&P 500 also climbed by 283,282% in all (including dividends), or 9.8% per year. Volatility in stocks is a feature, not a bug.”
Steep drawdowns are bound to happen and investors need to be able to ride out the paper losses and not be forced to sell.
Stocks can take months, if not years, to recover from a bear market. There have been 12 bear markets since World War II. These bear markets have taken two years to recover on average. The longest bear market occurred in the aftermath of World War II and took 61 months to recover.
Given the frequency of bear markets and the time taken for stocks to recover, I only invest money that I do not need for at least five years. Being forced to sell in a bear market could be detrimental to my returns and net worth over the long term.
Don’t leverage
Leverage can kill your portfolio in a bear market.
Leveraging essentially means borrowing to invest – or investing more than you can afford. The case for leveraging is that if you can borrow at let’s say 5% but have a return of 10%, then you can earn the difference.
However, there is one major pitfall to leveraging to invest in stocks- margin calls. If the value of your stocks falls below a certain threshold, brokerages who lend the money will force you to sell your stocks to ensure that you can pay them back.
During the Great Depression, the US stock market fell by 89.2% from top to bottom. If you had invested on margin, you would have likely been forced to liquidate your investments to pay back your lender.
Your entire portfolio would have gone to zero. That’s the danger of margin calls. Even though stocks eventually recovered, stock market participants who leveraged could not participate in the rebound and subsequent bull market.
The Great Depression was the steepest decline we’ve seen. But there have been other notable bear markets that would have likely caused margin investors to be completely wiped out. The Great Financial Crisis of 2008 saw a 53.8% peak-to-trough decline in US stocks, while the 1973-74 crash had a peak-to-trough decline of 44.9%.
Investors who invest with margin can gain some extra returns on good years but can easily be wiped out on the next downturn.
Invest in companies that can survive a downturn
I also invest only in stocks that can survive an economic downturn. Companies that have strong balance sheets with more cash and debt are likely to be able to weather the storm.
Most companies, no matter how strong their moat is, will likely see a fall in sales over the next few months. Even companies like Netflix, which on the surface seem unaffected by the COVID-19 outbreak, might see revenue fall as consumers are more conscious about their spending habits.
In a time like this, when companies are facing disruption to sales, it is important that we only invest in those that are able to service their debt, continue paying their fixed costs ,and still come out at the end of the tunnel.
Warren Buffett described it best when he said,
“Only when the tide goes out do you discover who’s been swimming naked.”
It is in times like these when companies that are over-leveraged and have high-interest cost may end up going underwater. Shareholders of these companies will be left grasping at straws.
The Good Investors’ conclusion
The stock market is a great place to build wealth over the long run. However, it is important that we abide by certain investing principles that help us survive a market meltdown, as we are seeing unfold in front of us.
These three simple rules help me keep calm during these dark times, knowing that this too shall pass.
Disclaimer: The Good Investors is the personal investing blog of two simple guys who are passionate about educating Singaporeans about stock market investing. By using this Site, you specifically agree that none of the information provided constitutes financial, investment, or other professional advice. It is only intended to provide education. Speak with a professional before making important decisions about your money, your professional life, or even your personal life.