The stock market has crashed. The FTSE 100 is down around 30% in the last three weeks. These are uncertain and disturbing times. The effect of the global response to the Covid-19 outbreak is without precedent, at least since the Second World War.
But amidst the panic and hysteria, I believe that the stock market has now presented the kind of buying opportunities that come about once in a generation.
Sure, company earnings will fall massively, for this year at least. It’s hard to imagine that many companies are going to be able to break even, let alone register profit growth. Some industries and companies with weak balance sheets will suffer tremendously, the most vulnerable will even go out of business. The global economy will probably go into recession. But it’s important to keep perspective.
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The world will go on
The virus does not represent a threat to the future of humanity, despite the tragedy of the deaths so far and those to come. Likewise, the future of capitalism is also not in danger. Businesses and the stock market will continue to be at the centre of the human world.
The way that we value investments is also not going to change. The value of a company can be derived from its future cash flows and from its book value (or net asset value). While interest rates are low, companies that generate positive earnings returns will continue to be sought after.
Before the stock market crash, the average UK stock traded at around 17 times last year’s earnings. By definition, this means that one year’s earnings make up just one seventeenth of a company’s valuation, or around 6%. If the effect of the virus is to eliminate this year’s profits, then share prices should only have fallen by this amount. Even if we assume that companies will suffer big losses for this year, it still doesn’t correlate to the stock market falls that we have seen.
It’s my belief that this is not the time to sell your stocks. That time was before the virus struck. Investors do not possess crystal balls. We can’t predict when we are going to hit the bottom of the crisis. Trying to do so is likely to result in missing any bounce completely.
Long-term investment opportunity
If you have cash to invest and have a long-term investment horizon (at least five years) then this could prove to be a great time to buy. I would be hugely surprised, if in five years’ time, share prices are not well above where they are now.
If we look back to the global financial crisis of 2008, the FTSE 100 fell by 30% in just over a month. Investors who bought the index at that time, would have had a gain of around 93% since (if measured before the start of the current crash). Investors who waited another three years to invest, would have had a gain of just 26%.
In the US, the S&P 500 recovered its entire loss (of 50%) in less than a year. Since the lows of that stock market crash, the US index has risen almost 400%, even after including the latest falls.
While it may be natural human behaviour to want to sell stocks at this scary time, I believe this is now the time to buy instead.
