Alternative Investment

Data That Can Help Investors In A Crisis • Money International

Estimated reading time: 8 minutes

Knee-jerk investment decisions are rarely wise, as volatile markets can lurch suddenly, leaving what seemed a good pick high and dry.

Keeping an eye on the bigger picture is essential to evaluate when and if moving prices are likely to be correct.

Global economic events such as the pandemic and the Russian invasion of Ukraine have countless impacts that stretch across sectors, national economies, and currencies. Still, the key is making informed judgements with the right data to provide plenty of insight.

Although a lack of responsiveness to influential factors is likely detrimental, it may also pay dividends to refrain from sudden decision-making, preserving invested capital and allowing sufficient time to research and assess all the relevant what-if scenarios.

Short-Term v Long-Term Investment

Short-term stocks are inherently higher risk than a longer-term position, contrasting with cash and liquid investment assets that tend to depreciate over the years. For example:

  • 30-day investments in the US stock market would be loss-making 40 per cent of the time, based on more than a century of market data.
  • One-year investments in the same markets would generate a loss less than 30 per cent of the time, a 10 per cent improvement in risk.

A 12-month investment is still relatively short, but these statistics show why past performance isn’t necessarily a surefire indication of how markets or stocks will move in the months ahead.

Investing in an up-and-coming stock for just four weeks could produce a loss if investor interest temporarily dips. However, the same stock could return a profit over a year or longer if the company is on an upward trajectory, even though it will experience a few inevitable peaks and troughs.

Investing over five years means a likelihood of a loss 23 per cent of the time, and only 14 per cent of ten-year investments fail, meaning that the longer your investment maturity date or crystallisation event, the more potential you have to gain.

While stocks can undoubtedly be loss-making over the long term, it is more unusual for this to happen.

Cash assets naturally erode due to inflation, with any money held as a fixed investment or within a low-interest savings vehicle providing less income in interest earnings than the cash is reducing by in real-world value.

Stock Market Recovery Periods

When an equity, index, or valuation suddenly tanks, the immediate response can be to bail, exit a position and sell as quickly as possible to avoid exacerbating the loss – and it could be a very costly mistake.

Research indicates that investors that remain invested in the stock market recoup losses far more quickly than those that switch stocks for cash assets to try to shore up their portfolios.

For example:

  • Investors who stayed with stocks after the 2008 crash took an average of 4.8 years to recover, whereas those who didn’t are still in a loss-making position.
  • Following the 1987 stock market dip, investors took 18 months to recoup lost funds, compared to 4.3 years for those who bailed.
  • In the 1929 Great Depression, investors required a more substantial 15.2 years to recover lost finances, but still much less than the 34 years for a portfolio where investors had replaced stocks with cash instruments.

Understanding these trends can help to side-step the mistake of assuming that risk and volatility in the broader stock market, even with the potential for ongoing declines, is a worst-case scenario.

Investors should always make astute decisions based on facts, data, and research rather than allowing the fear of a market drop to dictate their emotional response.

The Frequency Of 10% Falls

Stock markets drop by 10 per cent more often than not, which does not impact long-term returns or overall market growth. However, experienced investors know that short-term losses are the norm and are a trade-off for longer-term gains.

Weathering the storm usually is beneficial, with an average 11 per cent return on the US stock market over the last 50 years, even though the market has suffered falls of 10 per cent in 28 of those trading periods.

During the financial chaos of 2022, when economies struggled to combat inflation and the effects of conflict in Europe, equities dropped roughly 19 per cent. These higher falls have also been repeated in eight of the last fifty years.

Responding to a drop of 10 to 20 per cent with a sell-off can mean sacrificing the opportunity to make incremental, cumulative profits that average out, emphasising the importance of taking a longer view and selecting stocks based on wealth generation over an extended period rather than in the immediate future.

Volatile Stock Markets Can Be Good For Investment

It might seem obvious that an investor will opt to exit during uncertainty, market volatility or instability. Still, these periods can conversely be beneficial for stock market investors.

Over the last few months, there have been numerous impacts, such as:

  • Global inflation
  • Material scarcity
  • Tightened monetary policy

These influences create fear and worry, measured on the Vix index, which assesses the anticipated volatility that S&P 500 traders forecast in the month ahead.

Last May, the Vix hit 31, compared to a 30-year average of 20. The score was also 14 points higher than at the beginning of the year. However, based on historical data, selling at this stage would have been a bad move.

Investors that sold equities, prompted by a Vix of over 30, have found that their trading strategy underperformed. Consistent stock investment, regardless of the fear factor, would have returned an average of 9.6 per cent profit per year, compared to 6.7 per cent a year for investors that exited during higher Vix measurements and re-entered the stock market when it had subsided.

Evaluating past scenarios and performances shows that selling stocks during elevated volatility and investor doubt is less beneficial than retaining stock market investments until the climate reverts to the norm.

Investing Wisely During Market Crises

Investors rely on gut instinct, market analytics and portfolio diversification to respond to economic, socio-economic, and geo-political events that have the potential to impact their wealth, returns and future profitability.

Many opt to shift investments to safer sectors and industries considered a hedge against other stocks more exposed to market conditions.

Indeed, a market downturn might be an opportunity to invest in niche or stable stocks available at favourable rates when investment appetite is low and volatility is generally higher.

As demonstrated, the baseline is to rely on historical data and market assessments to make careful decisions without the temptation to respond erratically, emotionally, or out of fear, which in almost every case, will have negative outcomes.

Frequently Asked Questions

How do investors pick stocks during market slowdowns?

The right approach depends on the exposure of the investor’s existing portfolio, the capital they have available to risk, over what time frame, and their exposure acceptance strategy.

Examples include short-selling stocks or index futures, which means the investor profits from a drop in share prices, or where indices experience a drawdown.

What is the best way to avoid losses when stock markets are falling?

Investment strategies vary considerably, but multi-asset allocations across a diverse blend of asset classes are the most common approach to prevent excessive portfolio weighting in one sector or asset class that could be exposed to negative movements.

A balanced, diversified portfolio is more likely to return stable returns where stocks offset each other or where higher-risk stocks are counterbalanced by alternative investment products or financial instruments in an opposing sector.

Why should investors rely on historical data to make decisions based on current market conditions?

Although myriad factors currently impact stock markets, the Russian invasion of Ukraine and global inflation are far from the first times the markets have ever experienced this dual crisis.

Reacting only with diligent research is vital, ignoring the noise and trends with a rational approach to support a long-term investment strategy.

Markets almost always course-correct at some point, and reviewing averages and recovery periods during similar downturns is a favourable way to stay calm and possibly win big when markets start to rebound – when re-entering the market could be costly.

How long have previous equity market crises lasted?

Studying previous problems provides a wealth of historical data, which generally follows a trend. Stocks drop quickly, often dramatically, before recovering within 24 months.

Of course, this varies depending on the nature and extent of the conflict or economic factors negatively affecting the stock market. Still, most crises are short-lived and recover within one to two years of record lows.

Why do stock markets recover so quickly?

Equity markets adjust and adapt to current market conditions, whether they relate to conflict, recession, or demand. Investor trends also impact market movements, so where there is a mass sell-off or market exit, those investors that keep a cool head stand to benefit.

Time in the market is more important than trying to time the market to optimise returns.

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