The S&P 500 and Nasdaq indexes are both officially in bear markets. After nearly two years of continual gains, investors have been rushing to sell equities over the past couple of weeks as concerns about the economy and global macro environment have continued to mount.
There has been a general re-rating of equities across the market.
Speculative tech stocks were the first to start to feel the pain, but it has now spread to the rest of the market.
With inflation and interest rate expectations rising, analysts are now pricing in an economic contraction in 2023. If this materializes, earnings estimates for companies across the market are far too optimistic for the next couple of years.
During these periods of market turbulence, the best strategy for any investor is to sit tight, although that does not mean we should hide behind the sofa and ignore our investments.
Do not ignore the market
I believe one of the biggest mistakes investors can make in periods of economic and market volatility is to stick their heads in the sand and ignore the prevailing environment.
This mindset comes from comments from successful investors such as Warren Buffett (Trades, Portfolio), Seth Klarman (Trades, Portfolio) and Howard Marks (Trades, Portfolio). All of these investors advocate looking past short-term market volatility and concentrating on the long-term fundamentals of companies.
This is the best way to invest, but it requires work beforehand. If investors have not put in the work and do not own companies that are fundamentally strong with robust competitive advantages in the first place, holding onto equities that may only continue to struggle to grow in a hostile economic environment is a recipe for disaster.
Charlie Munger (Trades, Portfolio) has said investors need to be continually breaking down their own ideas to understand where the weaknesses lie in their portfolios and if there are any adjustments they need 4to make in changing economic environments.
This is something every investor should be considering today. It could be sensible to break down existing investment ideas to try to understand how they will cope in a high inflation environment and if they have the funding required to sustain themselves over the next couple of years.
Indeed, with interest rates set to rise substantially, I do not think it is unreasonable to say highly leveraged companies, or companies that have been relying on the kindness of strangers to fund loss-making operations over the past couple of years, will begin to struggle as interest rates increase and pools of capital withdraw from the market.
As the venture capital and private equity funds start to pull back and become more cautious, valuations in the private markets are already starting to come under pressure. This trend is already leaching into public markets.
Companies start to struggle
A couple of weeks ago, used car retailer Carvana Co. (CVNA, Financial) tried to raise new funding from investors to sustain losses. The market initially balked at the terms on offer, forcing the company to offer a significantly higher interest rate on its bonds and its founding family to step in as cornerstone investors for the equity raise.
So it seems sensible for investors to break down their existing ideas to see if they can survive the economic turmoil currently engulfing markets. If they cannot, there is no harm in selling out and finding a better opportunity. They will be out there as the sell-off has spread to almost every corner of the market.
At the same time, investors should leave companies alone that they have confidence in and look to selectively add to other opportunities when they are trading at attractive valuations.
There is no point trying to time the market. If a stock has fallen to a level that looks attractive, it could be an excellent investment.
With that in mind, here are three points to survive the current market climate:
- Continually break down your portfolio and review ideas.
- If nothing has changed, do nothing.
- Add to stocks selectively when they have fallen to attractive levels based on long-term (10 years or more) valuation models.
