The stock market’s recent decline reflects increasing levels of uncertainty among investors. Economic factors such as the potential for a faster pace of interest rate rises to curb the highest rate of inflation for 40 years may mean that the outlook for many companies appears less certain than it was a matter of months ago. Meanwhile, heightened geopolitical risks in Europe may also have caused investors to view the prospects for the world economy in a less favorable light.
However, risks are always present. There is always the potential for a wide range of threats and challenges to prompt a stock market crash that subsequently triggers a bear market. Indeed, this viewpoint has previously been expressed by Berkshire Hathaway (BRK.A, Financial) (BRK.B, Financial) Chairman Warren Buffett (Trades, Portfolio). In 2010, he commented:
“People talk about this being an uncertain time. You know, all time is uncertain. I mean, it was uncertain back in 2007, we just didn't know it was uncertain. It was uncertain on September 10th, 2001. It was uncertain on October 18th, 1987, you just didn't know it.”
Risks are a constant
Of course, Buffett is referring to previous market crashes that were not foreseen by the vast majority of investors. In 2007, the scale and severity of the global financial crisis took most investors by surprise, while few investors accurately foresaw the market crash of 1987. Meanwhile, few anticipated the dot-com bubble to pop. That's the nature of bubbles - investors get sucked in by greed to the point where they overlook the bubble until it pops.
Those events, like many others throughout history, occurred without any sort of specific trigger point. As such, it may be prudent for investors to avoid the assumption that risks can always be identified, and their potential impact understood, ahead of time. Furthermore, it could be logical to avoid the belief that some periods are riskier from an investment perspective than others. In reality, nobody can determine how the stock market will perform over a short time period.
A fundamental-led approach
In my view, it may be sensible to accept the future is always a known unknown and instead focus on investing principles. For example, this could include demanding a margin of safety before buying any stock. Similarly, it may mean only purchasing companies that have modest leverage, wide economic moats and long track records of consistent profitability.
Such companies may be in a better position to overcome challenging economic and political circumstances. They may also be more likely to capitalize on a long-term recovery.
Likewise, investors may be better off focusing on the stock market’s long-term prospects instead of worrying about today’s uncertainties. Ultimately, nobody knows how the aforementioned economic or geopolitical threats to global growth will turn out. However, the stock market has faced similar challenges in the past and yet has delivered an annualized total return of around 10% in the past 50 years. Therefore, a long-term view could yield strong results, albeit with volatility and uncertainty likely to be present along the way.
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