The Covid-19 pandemic may be an unprecedented health care crisis, but the bear market it has caused is not a new experience for long-term investors. The Dow Jones Industrial Average and S&P 500 have experienced numerous bear markets in their histories, with them having successfully recovered from them on each previous occasion.
One investor who has successfully navigated past bear markets is Peter Lynch. Therefore, at what is an uncertain time for investors, his investment strategy could be useful in capitalizing on the low valuations currently available across a wide range of sectors.
Experiencing losses
The losses being experienced at the moment by the vast majority of investors are a normal occurrence over the long term. According to Lynch:
“People who succeed in the stock market also accept periodic losses, setbacks, and unexpected occurrences. Calamitous drops do not scare them out of the game”.
It is very difficult to accurately predict every market crash, so experiencing temporary losses on specific stocks or across your entire portfolio is to be expected. The key for all investors is to take a long-term view and continue to invest in quality companies when they trade at low prices even during the most challenging economic periods.
Focusing on fundamentals
Buying stocks during a market crash can be a difficult process for any investor. All too often, emotions such as fear and panic can dissuade investors from capitalizing on low valuations available due to an uncertain economic outlook. Lynch noted:
“The trick is not to learn to trust your gut feelings, but rather to discipline yourself to ignore them. Stand by your stocks as long as the fundamental story of the company hasn’t changed”.
It may feel as though now is not a good time to buy stocks. Prices may move lower in the short run, but if a stock has solid finances and a sound market position, it could be even more appealing following a decline. By having the self-discipline to ignore other investors and go with your own instincts, you can access the stock market’s best value opportunities.
Managing risks
The financial strength of all companies is more relevant during bear markets than it is at any other time. Uncertain operating conditions and reduced demand from customers can cause many businesses to experience declining sales that put pressure on their financial position.
Therefore, undertaking due diligence on areas such as those highlighted by Lynch could be a valuable exercise that improves your returns:
“Never invest in any company before you’ve done the homework on the company’s earnings prospects, financial condition, competitive position, plans for expansion, and so forth”.
It is currently unclear how long the Covid-19 pandemic will last. Ensuring your holdings are in a strong position to survive the current economic crisis is a prerequisite for them having the opportunity to benefit from a probable long-term economic recovery.
Accepting uncertainty
Investing is, by its very nature, an inherently risky pursuit. The future rarely progresses just as any investor expects, and there are nearly always a variety of unexpected events which change the investment landscape.
However, as Lynch noted, investors must accept a degree of risk when buying any stock:
“Remember, things are never clear until it’s too late”.
If you decide to wait and see if a company’s financial performance will strengthen, or for its outlook to improve, its brighter prospects may have already been factored into its share price.
This is particularly relevant during market downturns. Since the economy’s growth rate often lags the stock market’s performance, you may miss out on recovery opportunities by waiting for the economic outlook to improve.
Buying strong businesses today while they trade at low valuations and holding them for the long run could be the most effective means of capitalizing on their growth prospects. While not without risk, the reward potential of this strategy is likely to be high.
Read more here:
- Charlie Munger's Tips on Controlling Your Emotions in a Crisis
- How Benjamin Graham's Advice Can Help You to Capitalize on This Market Crash
- Why Warren Buffett Thinks Timing This Market Crash Is a Bad Idea
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