How To Make Money In An Economic Downturn
The stock market has wavered this year after the Dow Jones Industrial Average (DJI) made an all-time intraday high on January 5th at 36,952. Since then, the Dow has fallen about 6.1% to 34,660. The S&P 500 (SP500) and NASDAQ (COMP.IND) have fared worse, as both of these indices have fallen by 6.4% and 13.4%, respectively.
Wall Street defines a correction as a 10%-20% reduction off highs and a bear market as 20% or more off highs. At one point, all three major US indices were in correction territory with the NASDAQ briefly in bear market territory.
Investors have felt more pain than meets the eye as many popularly owned stocks are in severe bear markets, despite US indices still being relatively close to their all-time highs. For example, Peloton (PTON) is down almost 80%, but in comparison, the NASDAQ is only down 13.4%. I simply picked a popular stock to make my point, but there are many other stocks with similar characteristics that are down just as much. Many investors own stocks, such as Peloton, and are seeing their profits evaporate in front of their eyes.
My goal for this article is to provide some historical facts regarding market corrections and bear markets, how to be a successful investor in these times, and propose some actionable takeaways.
Historical Market Downturns
By reviewing the following information, investors will increase their knowledge and gain perspective regarding current times.
Total Number of Corrections and Bear Markets
In the past 93 years since 1929, there have been 38 corrections and 21 bear markets. However, ten of those bear markets were from 1929 – 1946. In the 76 years that have followed, there have been 11 bear markets. That means there is a correction roughly every two and a half years and a bear market roughly every seven years (excluding those initial ten).
The lesson: Downturns happen routinely. Expect them and embrace them. If you are going to be an investor in stocks, every two and a half years you will have to suffer a correction and every seven years, you will have to endure a bear market. When an investor makes himself aware of the fact there will be market downturns, he is better prepared mentally and can make it through the storm. Conversely, the investor who neglects to acknowledge this, will be caught off guard and let his emotions force him to panic and sell stocks in loss.
Note: I included 9.6% – 9.9% as a correction by rounding up. I also excluded the initial ten bear markets to gain a more accurate representation of the timing of how frequently bear markets occur. The starting point for any comparison is crucial to how the data comes out – if I picked a decade with an abnormal amount of bear markets (either many or none), then the data becomes skewed and misrepresents the facts.
Average Correction and Bear Market Amount
The average correction is 13.3% and the average bear market is 37.1%. The average correction and average bear market lasts less than one year. In general, the average correction lasts around four months and the average bear market around ten months. Contrast that to the average bull market, which on average lasts about three years.
The lesson: Once in a correction, investors can anticipate a greater decline in their portfolios than 13% (unless 100% of the portfolio weight is in the corresponding index fund). The same can be applied to bear markets. Investors should not be investing money which they will need to pay for upcoming expenses. Due to the uncertain nature of the stock market, investors should only invest money they will not need for the next ten or more years. This allows the investor to weather corrections and bear markets without forcing him out of his position.
Tips for Corrections
These are tips investors must follow in order to be successful during the down times, but they also apply during the good times.
Rule #1 – Know What You Own
If you are buying stock in a company with products a 36-gigabit semiauto molecular thermal core 16 GPU processor with a 108 nano-bit terminal and built in H4-72 chip you are going to lose money.
Buy stock in companies which you understand. If you cannot explain to a ten-year old in sixty seconds why you own a stock, you should not own it.
I became one of the most profitable analysts (LINK TIPRANKS) by buying Dick’s Sporting Goods (DKS), Ruth’s Hospitality Group (RUTH), and Bank7 (BSVN). All of these companies are easy to explain:
Dick’s sells sporting goods. Ruth’s sells steak. Bank7 sells loans.
Rule #2 – Know the Company’s Finances
I will let you in on a little investing secret – if you can add single digit numbers, you know enough math to become a millionaire. I know that is not what Wall Street or your professors want you to believe, but I am here to tell you it is true.
Here are some basic checks of a company’s financial statements:
- Is revenue growing YOY?
- Are gross margins and operating margins improving YOY?
- What is net income? Is it positive? If not, is it going in the right direction?
- Does EPS go up every year?
- How much debt does the company have? When does it mature?
- How much cash does the company have? What is the cash burn rate?
- Does the company pay a dividend? Is it increasing?
Going through these questions will provide the investor with a solid foundation upon which to do further research.
Rule #3 – Your Brain is Not Important
Unfortunately, most investors learn the hard way the brain is not the most important organ when it comes to investing; it is the stomach.
Many investors can determine if a stock is undervalued. Few can watch the price decline despite that. These investors buy great companies at one price, then it falls, and they sell the stock at the lower price.
The primary cause is the investors do not know what they own and why they own it. When an investor buys a stock at random and the price falls, he panics. Why? Because he does not know anything about the company; he has no idea if the price is falling to its fair value or if it is falling below it.
If you buy a stock at $10 and hate it at $5, you had no business buying the stock in the first place. Before buying a stock at $10, make sure you will love it at $5.
Rule #4 – Walmart is Out of Crystal Balls
There is not a single analyst or writer who can predict short-term movements in the stock market. I read article after article on this site of writers saying, “I told you x months ago the market would be here today.”
As a general rule of thumb, anyone telling you they can predict the market is not making serious money in it and is trying to fool you into thinking he is smarter than everyone else. Day traders, swing traders, and short-term traders are usually broke. They make more money selling you their “Millionaire Guide Playbook” than any money in the actual stock market.
Invest for the long term. Contrary to how investors have been conditioned in 2022, ‘long-term’ does not mean one year. It means ten plus years. If you buy a stock and complain because it has not risen in four months, you need to change your investing perspective and time horizon.
When you invest with a short-term mindset you will get results proportional to that sort of investing strategy.
Rule #5 – Tune Out the Noise
Stop worrying about the economy.
The stock market got through WWI, The Great Depression, WWII, the brink of nuclear destruction, inflation, stagflation, some more wars, 0% interest rates, cheap money, Republicans, Democrats, the housing bubble, The Great Recession, COVID-19, and much more.
Buy great companies at good or better prices. Then ‘x’ out of your brokerage account and go enjoy your life. Come back in ten years and buy your family a nice house, car, and go on some vacations together. Save a little bit to give back to those less fortunate.
Here are some things the reader can do right after this article to immediately become a better investor than yesterday:
- Go through each stock in the portfolio and write down 1-2 sentences on why you own the stock. Consider it a “bull thesis” and make it as simple as possible. There are examples on Seeking Alpha on every stock if you need help. For example, a stock I own is Hims & Hers Health (HIMS). My bull thesis would be, ‘HIMS is a telehealth company offering patients appointments on their mobile device to acquire healthcare products. The company is growing rapidly with strong gross margins and is on the brink of profitability.’
- Write down five items from the company’s financial statements you identify as catalysts for future growth. This could be ‘x straight years of revenue growth’ or ‘debt consistently decreasing and cash consistently increasing. Then, identify some negatives. Is there any line item that is abnormal? Was there a huge non-core operating loss one year? Why? Could that happen again? Balancing your bullish instinct with a bearish one will help you analyze stocks more justly.
- Conquer your emotions. Understand the market is going to go down. If you learn to expect these times, it becomes a non-issue and you are better able to “cope.”
- Do not waste your precious time and try to predict market uptrends and downtrends. Also, steer clear from those who claim to have a crystal ball.
- Do not worry so much about the economy. If you take anything away from this article, please take away these two points: One, there are always a hundred reasons to sell a stock. Two, the bear case always sounds smarter. Great companies make it through hard times. Focus on identifying these companies and buy them at inexpensive prices when you can. This is where the real money is made – not in short-term trading.
I hope this article was able to be reassuring and provide some insight on market history and how to look towards the future. I cannot say how long the corrections will last nor if they will turn into bear markets. I can say, based on history, that if investors focus on great companies, they will be rewarded handsomely. Finally, I want to leave everyone with one of my favorite investing quotes:
You make most of your money in a bear market. You just don’t realize it at the time.
– Shelby Cullum David