Investing in Times of Crisis: Do’s and Don’ts
Crises and recessions make us see all the colors. At a time when the markets are plunging in the midst of the coronavirus epidemic, adding to the health crisis a financial crisis, LEVMAG draws up a list of the main misconceptions about investing in times of economic crisis, to better restore the truth and gives you the best practices to implement.
The Ukraine-Russia war and its devastating effects Internet bubble, the subprime crisis, and the Covid-19 epidemic, crises all have one thing in common, namely an astonishing ability to redefine old rules and change old habits.
So here are 5 misconceptions about investing in times of crisis to know.
Invest in the safest stocks to make money
This investment statement is only true before the onset of a crisis.
Indeed, safe havens are safer and will generally suffer a smaller decline than cyclical stocks, such as banking, commodities, and automobiles. But once the crisis takes hold, defensive stocks are likely to underperform because, once the market recovers, cyclical will maintain the strongest growth.
Thus, while you are holding the stock of a retail company that has appreciated by 10% despite the crisis, the shares of banks that have been massacred by the market could gain 50% during the rebound!
Above all, not all safe havens will necessarily hold up. It is therefore advisable to invest (for the less risk-averse) or to hold on to one’s shares (for the others) in leading companies that have been in existence for several decades (or even centuries), that have solid fundamentals and, in particular, a healthy balance sheet and debt, and that has the capacity to create added value over the medium to long term.
The crisis and the stock market crash must pass when the stock market rises
The stock market always tries to anticipate the end of a crisis, long before economic data, such as GDP, has confirmed it. Sometimes the market is right and sometimes it is not. In the latter case, the market would have recovered, only to fall back if the crisis proved to be more persistent and longer than expected.
This frequent phenomenon corresponds in terms of graphic analysis to the “Dead Cat Bounce” which indicates the bullish recovery, but of short duration, of the financial markets in a downward trend or in a more important correction.
Decoupling allows for more secure investments
Decoupling implies that high-growth economies, such as those in Asia or South America, have developed to the point where they can continue to prosper even if developed countries experience an economic crisis, which is totally false, as we saw during the subprime crisis, as global markets were all hit by the recession.
Emerging countries have indeed been able to record slight growth, while the US and Europe have been hit harder. But these emerging countries need strong partners to export their goods to western economies, for example.
As for the current health crisis linked to the Covid-19 epidemic, which started in China before spreading across the globe, it has obviously led to a global financial crisis and all the world’s stock markets are experiencing spectacular falls.
Real estate is a safe bet in times of crisis
Is it really necessary to point out how inaccurate this idea proved to be during the last decade? Deflation is symptomatic of economic malaise, which means that property prices are falling because supply is greater than demand, which cannot sustain current prices. Real estate is no exception: it is an asset like any other, and its price fluctuates according to economic cycles.
Let’s also remember that real estate was at the origin of the 2008 crisis. After years of unbridled construction, inventories had increased rapidly, causing prices to fall by more than 30%. The current health crisis could maintain a lesser impact on real estate prices, but this is by no means certain!
High-yielding stocks are not impacted during the crisis
A company that pays a large dividend can only afford to do so when it has maintained enough profits to pay out a portion of the dividend. In good economic times, the company may only have to pay out 20-30% of its net income in dividends (a good way to protect itself). But in bad times, a company’s net income can drop by 50%, putting the dividend payment into question.
In times of crisis, the price of dividend-paying stocks can face two sources of downward pressure: the first is the expectation of lower earnings, and the second is investors’ fear that the dividend may be reduced or eliminated.
Our advice to investors on investing in a crisis
Investing in the midst of a crisis is a humbling experience. Many respectable managers have considered the last ten years the worst of their careers, proving that even experts can be caught off guard. It will probably be the same for the coming year, which is even more unusual and destabilizing, since the financial crisis was caused by a health crisis, the Ukraine-Russia war, a situation unprecedented for our modern economies.
There are therefore many uncertainties about how the crisis will end. Will the expansion resume as soon as the epidemic is contained? Or will the recession be long-lasting and real? Indeed, the economy already weakened by the debt crisis may not recover from this period of confinement, which translates into a sharp slowdown in economic activity that could lead to the bankruptcy of the most fragile companies (and especially SMEs).
The best advice for investing during a crisis is to take the time to review your long-term objectives and readjust your asset allocation. Also, be prepared to accept no or low returns for one or two years if you already operate a nest egg or are close to your long-term investment goals.