Over the last couple of weeks, I have outlined why investors should act on this opportunity and buy stocks at bargain prices. Successful investors, including Warren Buffett (Trades, Portfolio), Peter Lynch and Seth Klarman (Trades, Portfolio), have backed this strategy.
Not many investors, though, would be able to pluck up enough courage to go against the grain during a bloodbath in global capital markets. Also, some investors might have cash constraints which would limit their ability to capitalize on falling stock prices. For both these types of investors, there’s an alternative strategy that could still yield attractive returns; do nothing. As absurd as this might sound, empirical evidence suggests this is a proven method of beating the market during a recession or a market rout.
The billionaire investor speaks out
One trait of legendary investors is they stick to the original plan no matter what. Even though there could be several ups and downs along the way, the big picture dominates the decision-making process of these investors, which eventually leads to success as it helps in canceling out the noise. Mark Cuban, the owner of the Dallas Mavericks basketball team, shot to fame when he sold MicroSolutions and Broadcast.com in billion-dollar deals in the 1990s. He has actively invested in both private and public companies over the last couple of decades.
The guru made some valuable remarks on the Cyber Dust mobile application in 2016, when global markets shed billions of dollars in fear of a significant slowdown in Chinese economic growth was imminent. His advice seems very relevant today. He said:
“While all the selling seems to be based on China and the price of oil, I really don’t know what the long-term implications for our stock market is. So I follow the number one rule in investing. When you don’t know what to do, do nothing.”
Once again, this is easier said than done as emotions can get the better of investors when there’s panic in the markets. Before concluding whether this strategy is worth exploring any further, however, historical market routs need to be studied in line with the returns realized by this strategy.
Two recessions, one lesson
There is no better way to evaluate a strategy than to analyze historical performance. In the last couple of decades, markets saw two of the most catastrophic events in their history; the dotcom bubble and the financial crisis. Both events were centered around a single business sector. In 2001, it was the tech stocks. In 2008, banks and financial companies led the charge in wiping billions of dollars off the market. There is, however, one important lesson to learn from these downturns; an investor who did nothing but wait ended up winning in the long term.
When the tech bubble burst in 2001, it looked as if markets would never recover and that the tech sector would never surpass the highs seen before the crisis. However, this was proven incorrect. In fact, the sector has provided stellar returns since the fallout of the dotcom bubble. As illustrated in the below chart, the Nasdaq Composite index has almost doubled from the highs reported before the market crash in 2001.
Evidently, it would have paid to do nothing but let the market work its magic. The table below shows the performance data for a few large-cap tech stocks since the 2000s:
|Peak reached during the dotcom bubble
|Current market price (March 10)
|Microsoft Corp. (MSFT, Financial)
|Apple Inc. (AAPL, Financial)
|Amazon.com Inc. (AMZN)
|Adobe Inc. (ADBE)
|Intuit Inc. (INTU, Financial)
What is more noteworthy is that all these stocks posted double-digit declines when the bubble burst, and investors and analysts doubted the mere survival of these companies in the long term. However, an investor who was oblivious to the noise and did not act on sentiment would now be sitting on unprecedented returns.
This is identical to what happened during the financial crisis as well. Even though banking stocks collapsed in 2008, an investor who held on to this sector would now be sitting on healthy returns. For instance, Buffett continued to buy big banks during this period, but even a do-nothing strategy would have helped investors immensely.
This evidence leads to the conclusion that Cuban is right that not doing anything could also be a successful investment strategy when investors are not entirely sure whether to buy or to sell.
Allocating assets the right way is important, but this may not be the best time
Despite renowned investors like Ray Dalio (Trades, Portfolio) highlighting the importance of building a diversified portfolio, many investors tend to follow the herd and invest in what are deemed as "hot stocks." These types of investors might find it difficult to do nothing when markets crash as their portfolio value would drop at a much higher rate than that of an investor with a high-quality asset allocation spread across gold, equities, bonds and liquid assets. Clarity Financial Director of Financial Planning Richard Rosso told U.S. News:
“Your gut reaction is to sell. That is probably because you don’t have your allocation set correctly.”
Investors who have got this wrong might now be alarmed and are probably considering the possibility of getting it right by selling equities and investing across various asset classes. This might not be the correct time to do so, though, as stock prices are already depressed more than they should be. This is a good reason to do nothing at this time and wait for a better opportunity to diversify portfolios. Ideally, the high exposure to stocks should be minimized when markets are soaring, not when tanking.
Takeaway: If you are not sure, the best strategy is to wait this out and do nothing
Undoubtedly, an investor who is confident and brave enough to capitalize on this market downturn by betting on falling stocks of great businesses will beat the market in the long term. However, the general tendency of many investors is to sell their holdings and wait until the sentiment recovers, which is likely to be too late to reap the best rewards. Investors who are not sure of the long-term prospects for the American economy and markets should shut out the noise and avoid following the markets at all until such time they feel the normal cause of actions are resumed. Doing nothing right now will help avoid severe losses that could arise as a result of irrationally selling stocks or investing in sectors that are likely to remain under pressure beyond the investment horizon of investors.
Disclosure: I do not own any stocks mentioned in this article.
Read more here:
- Sectors to Watch Out for as Oil Crashes
- Warren Buffett Bets on Delta Air Lines Again
- Learning from Peter Lynch: How to Survive a Market Correction
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