In the Chinese language, the symbol for the word “Crisis” is being composed of two characters signifying “Danger” and “Opportunity” respectively.
Everyone investing in any instrument and market knows that investing goes with “ups” and “downs”. The “downs” that we are experiencing during the last several months are nerve-wracking.
The news around the coronavirus is keeping everyone busy with bitter feelings and uncertainty about everything that is happening today and the unknown going-forward. The markets are reacting with a massive swing that no-one can follow reasonably.
At the beginning of this period, everyone thought that the outbreak of the virus will be with limited regional impact and the markets will be resilient enough to absorb the effect of it.
There were many positive indicators as low-interest rates, inflation, unemployment and the stimulating attitude of the regional central banks. Despite all this, we see that the corona outbreak is leaving deep scars on the financial markets, apart from the human suffering with increasing numbers of fatalities.
The leading stock markets in all three global regions are showing massive declines unseen since the 1987 crisis. All three US, European and Asian indexes are firmly in bear markets as defined by declines of more than 25% from recent 52-week highs.
Those kinds of steep falls feel extremely uncomfortable and destroy the sense of (financial) security. Man’s first reaction is to run and do everything in their power to escape further destruction, but as described in any book or definition about stock markets: that is probably not the best strategy to follow when it comes to investing.
This is why it takes more than average willpower and determination to remain calm and get reasonable answers to the most pressing questions.
What is contributing to this uncertainty?
First of all – coronavirus! The coronavirus is a so-called “black swan”: an event that you cannot predict, but that can have major consequences. We all expect that the virus will get under control with all of the measures that governments are currently implementing.
We are already seeing positive news and developments from China and other regions in Asia.
The big pressing question at the moment is: When will this happen in the rest of the world?
This mainly depends on the effect of the measures that Europe and the United States are implementing against the further worldwide spread.
On top of all that, we are also dealing with the uncontrolled oil-war with Russia unleashed by Saudi Arabia, as a result of which oil prices have plummeted in a short time. That is beneficial at the gas pump, but detrimental to the financial future of oil companies in the US and beyond.
Let’s extend this information to the investment community and see how does the basic process work. Investors like to know if the price of a stock or bond is in proportion to what they get for it.
The events surrounding the coronavirus and the oil sector make it difficult to get this calculation right. To do this properly, there is a need for an estimate of future economic developments and profit- and turnover expectations of the enterprises on the stock exchange.
In the current conditions, this is difficult if the expectations are constantly adjusted downwards, as we are confronted almost daily with reports that countries are closing the borders, transportation is shutting down, workers are sent home, schools are closed and more.
And if investors don’t like something, it is one thing: uncertainty about the future. The past (including the 2001 internet bubble-burst, 2008 financial crisis, 9/11 attacks) has taught us that expectations get very quickly downwards adjusted and too low in many cases. This, in turn, leads to sharp falls in stock prices, which according to historical data is often followed by a sharp profit in the period after.
Central banks must come up with support measures, as they all did. However, unlike previous periods of tension such as the 2008 financial crisis, they are not enough to calm markets. This time, the source of all the turbulence is not the financial system, so that only monetary aid is not enough. Monetary policy must fully support the fiscal policies of governments.
How am I affected?
Despite the storm on the stock market, it is important to remain calm. We are all aware of this from the theoretical point of view, but it is not easy when you see your carefully built capital shrinking by the day. Nevertheless, it is an important starting point.
Research shows that investors often make choices based on feelings and emotions, often irrational and wrong choices. An example in behavioral finance (a scientific approach to human behavior in finance) is the “loss theory”.
This theory shows that “losses” and “profits” are differently valued by people: it turns out that the negative sense of loss can be twice as powerful as the positive sense of profit. As a result of it, the investor places too much emphasis on “not losing money”, and too little on the “chance of profit”.
With this knowledge in mind, we know that it is extra difficult to stick to your original investment plan if the stock markets fall for days, weeks or months.
The most important thing is to recognize these pitfalls and to ensure that you avoid these wrong choices as much as possible. This requires a systematic and systematic way of working. Looking at the investments with distance and without emotion. Easier said than done!
What can you do best as an investor?
Chances are that your portfolio is currently not in line with any reasonable expectations and objectives. This happens under the influence of extreme unrest and ditto circumstances.
The past has taught us that this is not the time to make drastic changes to any strategy or policy. In fact, adjusting the portfolio now increases the likelihood of missing a recovery that will sooner or later materialize.
The dilemma remains: if you get out now, when do you dare to get back in?
Chances are, due to emotions, you will be waiting too long, along the side-lines.
What is smart to do now?
Do I have to buy or book cash now? That is a question that is difficult to answer unambiguously. You may know the statement “buy the dip” (buy at the lowest point) and this could be a very nice moment to start looking back. But watch out! This does not have to be at the lowest level.
Consider in advance whether buying now or expanding risk in the portfolio suits you. If this is the case, additional purchases are worth considering.
If at some point it is time to buy, what should you buy? When indicators start showing that the crisis is softening, you may start considering a graduate refill (or periodical re-purchase) of your current positions to equalize some of the loses and as the time goes, invest in the sectors most affected by the crisis as airlines, transportation, food and hospitality, retail and oil companies.
Note that governments will start bailing i.e. airlines and some other sectors and therefore gain significant shareholding of those corporations, which might result in decreased interest of the current investors.
Those sectors will require a much longer period to recover the losses and return to growth and profit. In situations like this, you can always be better at the market leader (i.e. Apple, Google, Amazon, Facebook, Microsoft), simply because of the strong balance, and they may be able to take advantage of the slump in smaller players. An alternative will be to invest in indices and use their balance protection and safety of their spread.
Disclaimer: “The information contained in this blog is not intended to be a source of advice or credit analysis with respect to the material presented, and the information contained does not constitute investment advice.”