The world economy is constantly evolving. However, the pace of change across some industries may be faster than usual currently due to containment measures put in place in many major economies.
For instance, e-commerce sales could grow rapidly as shoppers become increasingly familiar with ordering groceries and other products online.
One investor who has experienced many economic changes in his career is Peter Lynch. His ability to reassess the financial prospects of his holdings and adapt to an evolving economy could be key reasons for the 29% annualized returns produced by his Magellan Fund between 1977 and 1990.
Holding sound businesses
The challenging economic outlook has caused many investors to become fearful. Evidence of this can be seen in the Vix index, which measures investor sentiment. It has doubled since the start of 2020, which suggests that investors are significantly more worried now about the stock market’s outlook than they were five months ago. This has prompted many investors to sell their stocks in search of lower-risk assets.
Ignoring your emotions and holding quality businesses over the long run could be a better strategy, however. Companies with strong balance sheets could be in a better position to survive economic challenges in the short run, and may successfully adapt to changing trends that strengthen their market position over the long run.
Lynch has previously discussed the importance of holding on to stocks during volatile periods for the economy, saying: “The key to making money in stocks is not to get scared out of them.”
Reassessing your holdings
Some companies may not be in a strong position to adapt to changing consumer trends and an uncertain economic outlook. For instance, they may have high fixed costs that cause a drop in their sales, hurting their financial performance to a greater extent than their peers.
Therefore, reassessing your holdings and selling those businesses that have unattractive fundamentals may allow you to adjust to a changing economic outlook. This may cause losses that are painful to experience. But over the long term, this strategy could position your portfolio more effectively for growth.
Peter Lynch has previously highlighted his attitude towards existing stock holdings that have poor outlooks, saying: “There's no shame in losing money on a stock. Everybody does it. What is shameful is to hold on to a stock, or worse, to buy more of it when the fundamentals are deteriorating.”
Undertaking thorough research
Analyzing companies before purchasing them is always important. But it could be even more crucial during a period where changes in demand and evolving consumer trends are likely to take place rapidly across many industries.
When analyzing a company, it is not possible to understand exactly how it will perform in the future due to there being a range of known unknowns. Therefore, purchasing businesses with wide economic moats and large margins of safety could reduce your portfolio’s risks.
Lynch has highlighted the importance of analyzing companies and their prospects in the past. He said, “If you don't study any companies, you have the same success buying stocks as you do in a poker game if you bet without looking at your cards.”
Making mistakes
Predicting how the economy will evolve is impossible. Previous trends may or may not continue. Therefore, no investor will be able to accurately forecast the performance of every one of their holdings.
Even though you are very likely to make mistakes when selecting which stocks to hold, buying a range of quality companies and holding them for the long run is likely to yield high returns. For instance, the S&P 500 has returned over 10% per year since 1945. Its future returns may or may not be as high as this level, but are very likely to beat other assets.
Lynch has invested in many companies that have delivered disappointing returns in the past. He has previously highlighted that all investors make mistakes when it comes to apportioning their capital. He said, “In this business, if you're good, you're right six times out of 10. You're never going to be right nine times out of 10.”
Read more here:
- Bill Ackman on Managing Your Portfolio in a Volatile Market​
- Benjamin Graham on Trying to Predict the Stock Market's Future
- Seth Klarman on Investing During a Recession
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