Not understanding what is happening in the markets (and probably in your retirement fund savings) can make a stressful time much worse. In two short videos, 10X Investments founder and chief executive officer Steven Nathan explains a few basic underlying concepts and warns against acting in a way that will lock in your losses ie make them permanent
Why is coronavirus causing the stock markets to crash?
The stock market takes a long-term view on the value of companies, on the earnings they will generate into the future. When you buy shares in a company you are buying the right to the earnings that come out of that company for a very long time.
What is happening now is that the stock market doesn’t actually know what earnings are going to be. We were on a reasonable growth trajectory, where people thought the future was certain. All of a sudden, we see this big economic slowdown because people are staying at home and companies are being told to close their doors.
There is no question that this is going to have a dramatic, negative impact on companies. There are always some winners, for example companies that supply medical supplies and equipment and some online retailers, but there will be more losers than winners.
What the stock market declines tell us is that if this negative environment persists these companies are going to be worth less. It is probably true that they are going to be worth less, but not necessarily a lot less.
In the stock market you have a buyer and a seller. What tends to happen in crises like this (and we have seen this many times, this is nothing new) the stock market tends to overshoot, both on the down-side and the up-side.
What is happening now is that a lot of people want to sell, nobody wants to buy. In a normal market, the price view of buyers and sellers is quite close. In a down market they are very far apart. That is why share prices are falling dramatically right now.
It does look like the stock market reaction is way over done. We have seen share prices fall in the region of 30% in a short space of time, but it is unlikely that the value of these companies into the very long term is going to be 30% less. It might be 5% less, or 10% less, but highly unlikely to be worth 30% less.
We would expect that just as the markets have reacted very sharply on the way down, when things normalise demand will recover and we can expect the stock market to recover quickly because there will be many buyers and few sellers.
We don’t know how long that is going to be, but certainly within 18 months to 2 years you should have recovered most, if not all, of those losses.
It wouldn’t be a wise strategy to sell out now, particularly if you are still a long-term investor and your time horizon hasn’t changed. The chances are you are going to lock in a loss and you are going to miss the recovery.
What we learned from the 2008 crisis
If we go back to the Global Financial Crisis in 2008 and read the financial media from the time, what people were saying was that we were going back to 1930’s Depression era economics, and that we had to get used to the ‘new normal’. They predicted that we were never going to have the same lifestyle, we were never going to have the same returns. It was a real doom and gloom scenario. But things just didn’t turn out the way people were expecting.
It took roughly eight months to get to the peak of the crisis and another about 10 months to recover.
So after 18 months your investment value had recovered, you had made it all up. In the subsequent years the returns were very good as the market and the economy recovered, and we were back earning good, inflation-beating returns.
So after a few years there really wasn’t anything for people to worry about … had they stuck it out.
Also, it is important to remember that as retirement investors we are buyers of shares, we are not selling shares. We should welcome lower prices because we get more value for our contributions. For our monthly contributions and reinvestment of dividends and interest, we are getting more units, better value for that money.
Ironically, what that means is that when the markets recover, we will be better off.
Watch the full series of short videos, Investing in uncertain times here.
Steven Nathan is the CEO of 10X Investments.