Yahoo Finance Five investing lessons so you can be prepared for the next market event
Let’s make a very big assumption that the bear market has run its course. Let’s assume the market is back to normal, whatever that is. The decline will go down in history as deep, painful and widespread, but at least it was over in a bit more than a year (depending on what market or asset class you’re looking at).
Why are we making this assumption? It’s to see if anything can be learned from the disaster that has been stocks and bonds in 2022. Let’s look at five lessons, so you can be prepared for the next market event.
Long-duration assets fall fast when interest rates spike higher
Most investors know that bonds with long maturities have more leverage to interest rates than short-term bonds. In other words, a 30-year bond is going to decline more than a five-year bond when rates rise. This is fairly basic stuff.
But investors seem to have forgotten that stocks, essentially, don’t have a maturity date. They are perpetual (unless a company gets taken over or goes private). Thus, it stands to reason that perpetual assets are going to take a bigger hit than those assets that mature when rates rise. This is exactly what happened in 2022.
Stocks took a big hit. Companies that were losing money and were years away from any profits got destroyed by the stock market. Many investors wondered how the stock of a $50-billion company could decline 85 per cent in less than a year. Now they know it is a perpetual asset in a time when interest rates spiked.
Don’t buy hyped IPOs
Investors will ignore a lot of risks when they’re confident. They will pay excessive valuations for “hot” initial public offerings (IPOs). But these valuations can start to look ridiculous when things turn cold.
Generally, IPOs are to be avoided. Sure, one will occasionally pop and generate a ton of media attention. This creates a lot of FOMO (fear of missing out) for the next IPO. But as individual investors, it is very hard to secure an allotment of a hot IPO. Shares are typically reserved for large institutions, or favoured clients. In other words, if you can secure shares in an IPO, it’s likely one you shouldn’t own.
Let’s look at a few of the blistering hot IPOs of 2020/21 and how they have fared in the bear market. GoHealth Inc. went public at US$21 per share in 2020; current price: 44 cents U.S. per share. Affirm Holdings Inc. went public at US$49 in January 2021; current price: US$15. Root Inc. went public at US$27in October 2020; current price: US$8.
In the next market cycle, it might be a good idea to stick with long-established, quality companies rather than taking a flyer on the next new thing.
Use common sense, people
We have used the example that follows before, but it is just so perfect to illustrate that investors tend to forget the basics in a bull market. They forget the risks. They forget the conflicts.
So, we have the case of Nikola Corp., a Tesla Inc. wannabe that took advantage of the electric-vehicle (EV) frenzy to hype its e-trucks to raise billions. At one point, Nikola was worth more than US$50 billion. It is worth US$1.4 billion now. It will have a total revenue base of about US$77 million this year.
Nikola is famous for rolling a truck down a hill to showcase its technology. That’s right: it rolled a truck down the hill, because it had no power at the time. But even after this staged event, the company still had a multi-billion-dollar valuation, because investors ignored common sense and loved the EV industry too much. Did we mention its former CEO was convicted of fraud in October?
The end must be near when the tulip bubbles appear
Of course, hindsight is always 20-20. But the rise of non-fungible tokens (NFTs) was surely the tulip-bulb equivalent of this market cycle. Investors should have noticed the investment world was not normal when the equivalent of a JPEG, or screen shot, of an animated monkey sold for US$630,000 (note that we did highlight the ridiculousness of NFTs last year). The above-mentioned monkey, sold to influencer Logan Paul, is now worth US$10.
NFTs are a classic case of an investment that is only worth something if someone else pays more for it. They, of course, have little utility, no interest or dividends, and don’t create value, like a company could. Heck, even with the tulip bubble, you could at least grow some flowers with your half-million-dollar bulb.
Corporations have longer time frames than investors
One lesson to take away from the bear market is that corporations tend to think longer term, and individual investors tend to think in very short time frames.
This can be shown by all the merger activity and share buybacks over the past year. Individuals tend to extrapolate, and suffer from recency bias, thinking that a down stock today will continue to decline. Corporations, on the other hand, look at opportunity. If its stock is down, that means they can potentially buy a competitor much cheaper.
Yes, higher rates have slowed this game down. But if you haven’t noticed recently, there still seems to be a deal or two every week. We have seen plenty of mergers in the gold space, health-care sector and industrials.
Investors fret about this quarter, but companies think in decades. If the bear market is indeed over, and stocks still don’t stage a big rally, watch for an acceleration in corporate activity as overall confidence returns to the boardroom table.
Peter Hodson, CFA, is founder and head of Research at 5i Research Inc., an independent investment research network helping do-it-yourself investors reach their investment goals. He is also portfolio manager for the i2i Long/Short U.S. Equity Fund. (5i Research staff do not own Canadian stocks. i2i Long/Short Fund may own non-Canadian stocks mentioned.)
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