Last Updated on 12 January 2021 by Dan
Hello everyone! With the market falling substantially recently in response to the Coronavirus, today we look at if you should consider if it may be worth investing in a “down market”.
Please note this post was originally written back in mid-April 2020. Whilst I still believe many of the sentiments are accurate, it’s now somewhat out of date.
This post is aimed at those who have a reasonable amount in savings or are financially secure enough to invest in the market and possibly take a loss – if you”re feeling the pressure in the present difficult environment I’d recommend taking a look at this post instead discussing actions you can take to improve your financial security.
If you’re new to investing or giving going into the market some thought, I’d have a read through our starting to invest series first, which provides a run through of why investment is generally a good thing, some methods you can use for investment and how to understand your own risk profile.
Secondly I should point out the usual disclaimers on this kind of post that this is my personal opinion on the markets and no way forms official “financial advice,” – you need to consider your own financial risk appetite and position before you make any investment decisions and we can’t do that for you.
This goes double at the moment because the markets have been a wild ride recently and elements of unpredictability are even higher than normal! Simply put, you should be comfortable you’re taking the right position for you when making decisions.
Today I’m going to look at the arguments for investing now, the arguments against investing now, explain what I’ve done myself and some other factors to consider.
(Just for full context, in the below I’m talking about the market in a general context rather than homing in on specific companies or sectors. It may be possible to make an investment case for or against specific names or areas based on fundamentals or issues unique to a particular name or area)
The case of why you should invest
Whenever we’ve seen a recession in the stock market, there’s a consistent pattern in the way the market has moved. Specifically, the market falls fast and viciously, usually in response to a unexpected event (for example oil prices, the banking crisis and in this case Coronavirus).
In the period afterwards, there’s an immediate sharp (slight) correction upwards and selling pressure turns to buying pressure. Volatility usually drops at this point before the market gradually gradually begins to recover via a slow upward trend, going beyond the position the market originally reached. Then, the whole cycle starts all over again.
So far we’re entirely in line with this expected pattern. Based on solely this, you might conclude that we’re at the beginning of that long upswing and it’s therefore a good time to invest for the long term.
In fact there’s potential arguments this time that upswing leg may be faster than normal. Comments by Andrew Bailey, new Head of the Bank of England suggest that in GDP terms at least that models show the best case scenario being a strong “V” shape in terms of recovery where after a sharp fall the markets recover quickly. (It’s important to note this is in the context of economic growth, not the stock market and I emphasise this is best case amongst a number of scenarios). (UPDATE: Since I wrote that, Andrew Bailey has more recently commented that he sees some of the very negative economic forecasts such as a 35% drop in GDP as credible.)
From a “instinct” perspective you might think that this makes sense. With production and sales dropping as shops are forced to close, it only makes sense markets will drop – when they reopen again, things may go back to a sense of normality and you may expect the market to go back to a similar if perhaps slightly dented position as before.
With infection and death rates appearing to decline, an assumption might be made that we are on or near the “peak” and as such that path to recovery is beginning to visibly appear, and is feasible within the relatively short term of a couple of months. Fundamentally, the argument is made that this is a blip rather than a true correction, and there’s gains to be made.
The argument why you shouldn’t invest right now:
There are also plenty of convincing arguments against investing in the market right now.
Starting with the obvious, there’s still so much we don’t know about the virus.
We think we’re over the peak, but we’re not sure. There’s still vast swarths of the population who have not contracted the virus, and it’s feasible that if social distancing was relaxed a second wave of cases could appear.
Whilst people don’t think that you can get the virus twice, we also don’t know that for sure (there have been reported cases from South Korea of recurrence – however it isn’t clear if this may be caused by issues with testing rather than the virus rearing it’s head again).
As a result our ability to predict the future is somewhat limited – future lockdowns or impact to us as a population are not knowns, as such such we may not be as “out of the woods” as at first appears.
There’s also the second order economic impact. At the moment, many companies (even large enterprises) are struggling with their cash flow – I.E they still have large bills and outgoings to pay, but don’t have the revenues coming in from their sales to balance in out. If they have significant debts as many enterprises do, they may be forced into bankruptcy if they cannot pay them in the short term.
This creates a slight domino effect around the market – company A goes bankrupt, meaning their supplier company B does not get money it was expecting and causes problems for it etc. etc. The cumulative effect of this places the overall economy in a worse shape than it otherwise would be and creates a nervous environment where people do not want to spend because they are worried about credit.
Some analysts were also arguing sections of the market were looking overvalued (I.E that the price of stocks were unreasonably high given the revenues those companies were generating.)
Finally the US bank earnings reporting last week also showed them taking large provisions. A provision is where you put money aside for large losses in future, and is a sign they see a substantial recession upcoming.
If you take this view, markets might not also recover to where you think they might.
The middle ground
One other potential theory some analysts are putting forward is that elements of both will occur and this will be a non-traditional market event which will look more like a “W” than a V, or a “double dip” which you may remember as a term from a last financial crisis.
This would see an initial dip and recovery, followed by the same pattern occurring again in a couple of months as the credit events start to hit.
There’s a larger question over if the forecast of a recession is priced into the market already, or has yet to be fully accepted by equity markets.
My own position
Firstly, there’s what I’ve done in respect of positions I held prior to the market volatility:
I have not sold out of any positions I was holding prior to the peak, even if some of those positions moved to an on-paper loss.
(For those unfamiliar with the term, an on-paper loss is simply where if you’re have a stock holding and if you theoretically sold it today you’d take a loss).
Selling your portfolio after a fall is something I’d only advocate if you absolutely need the money or I severe concerns about the viability of a particular company you’re invested in. (And I emphasise the benefits of diversification in the starting to invest series to mitigate this).
The reason for this is that the pain has already happened – by investing for the long term you can take it, because as we’ve already explained markets consistently show a pattern of recovery after sharp falls, and by dropping out of the market you take that large loss and don’t benefit from it. It can be difficult to do this because the panic emotion can set in that you may lose everything you’ve saved for.
Often the best thing to do is to “keep calm and carry on”. Peter Lynch, who was one of the great investors at Fidelity Investors noted that often the best way to get rich long term was invest and never look at a newspaper, because it helps you avoid those panic moves.
(By the way, Lynch is one of those people who really inspired me into investing. I’d recommend having a look at a couple of his books if you’re looking to learn more about the markets – they’re very accessible).
Secondly, there’s what I’ve done since the market volatility:
I see the merits of the pro and anti arguments. I used some savings balances to buy into the markets again via a position in a diversified index fund, on the basis that markets are historically cheap right now, and no matter if a “V” or “W” approach occurs in the economic metrics, both forecasts result in an expectation of recovery over a 5-10 year period.
I accepted when doing this that I might take some further losses if the situation were to worsen further or something unexpected might happen.
However, I’d make an important distinction that I bought on March 23rd as I saw the news cycle appeared to be turning from constant bad news that was only piling on market pressure. The market has gone up substantially since that moment – on the recovery leg of the V or the early stage of the middle bit of the W is a matter of interpretation.
I do think there will be some further disruption in the market as bankruptcies and defaults occur owing the pressure happening now, however I think it’ll be more contained than the present market wide impacts, as lenders appear to be taking a largely pragmatic approach where otherwise good companies would be able to meet their obligations outside of the present disruption. Which isn’t to stay that we couldn’t see substantial economic pain.
As I’ve emphasised before, I believe events like this just highlight why you invest for the long term and never the short term. You avoid being fazed by these market dips because you know they will happen.
As mentioned above I invested in a diversified index fund, which provides exposures to lots of different companies over a wide range of sectors. I would have been far more uncomfortable investing in a single name stock unless I had a really in depth knowledge of the particular company and how it’s valued.
Even amongst good names, individual companies are facing a significant amount of pressure to their survivability. There’s too many unknowns about the longer term impact of this virus on financial flows for me to be any way comfortable that I can model out the finances of a company and feel comfortable they’re reasonably reliable. By diversifying, you avoid the risk of losing everything on a bad choice.
There’s another end I could have gone to, and that’s investing in one of the companies which is doing well during the Coronavirus crisis because their business model places them in an advantageous position. Some examples of this might be Zoom (where suddenly there’s a huge rise in demand for teleconferencing services) or Amazon (which has seen a huge uptick in orders as one of few open businesses).
I’m avoiding these simply because they’ve already performed well and people know it. Thus the present price already reflects expectations that these companies will perform well and there’s little more gains to be had. I may of course be wrong and they’ve still got further to go!
I was happy to buy at the cheaper price the market was at a couple of weeks ago. I’m still planning on investing the small regular amount that I put in from my monthly paycheck. I’ve given some consideration to making additional buys, but the shape of the potential upcoming credit events, and being unable to judge the severity and knock on’s leave me nervous of investing more at present valuations.
So, I wouldn’t stick my life savings in, and those coming out at the lower end of risk profiles (which you can read all about here) may want to steer clear of the market altogether right now.
Long term, I believe there’s extremely good prospects of market recovery. Very simply we continue to advocate that investing long term really does pay off – you can read more about why here.
So if you’re going to need that money back in a year, I’d definitely think twice. If you’re willing to wait five or more…. well, speaking for myself I wouldn’t invest now. But I might be looking for a point soon where I consider buying some additional equity.
Good luck, and remember to research and think about your own position before making any financial positions!
And we always welcome your own thoughts about the market or any questions in the comments below!
A few useful links to previous posts which are referenced above – these are all from the starting to invest series:
- Why investment is a good idea and can pay off.
- What options are available for investing
- How to understand your investment risk profile.