The potential for further stock price declines after the recent market crash may dissuade some investors from buying high-quality businesses today.
However, predicting the stock market’s performance over a short time horizon can be problematic, due to the wide range of inputs that can affect its prospects.
Therefore, buying companies while they offer wide margins of safety could be a shrewd move. They may be able to deliver impressive performance in the coming years.
Predicting a stock market crash
Trying to forecast when a market crash will occur is exceptionally difficult. For example, the recent pandemic was an unprecedented event that wasn’t on the radar of the vast majority of investors. Trying to predict what happens next may prove to be an equally difficult task. Especially when you factor in risks, such as a possible second wave and geopolitical challenges between the US and China.
Other crises, such as the global financial crisis, were also unforeseen by many investors. And, perhaps more importantly, the scale of recovery from them wasn’t anticipated by most investors while the economic outlook was at its worst and stock prices were at their most attractive.
Buying undervalued stocks
Therefore, predictions about the prospect of a further market crash may prove to be of little value in the coming months. By contrast, a strategy that focuses on buying the best-quality companies in an industry that faces an uncertain future could be highly profitable. They may be in a strong position to survive a period of economic difficulty. They could even seek to expand their market positions through taking market share away from competitors.
Moreover, even if the stock market experiences a further downturn, its recovery prospects appear to be bright. The stock market has been able to produce annualised total returns in the high-single digits over the long run. It’s also successfully recovered from even its very worst bear markets to rise to new record highs.
Therefore, a strategy of purchasing stocks and holding them for the long term, even with the threat of a market crash, is likely to yield a higher return that that on offer via other mainstream assets. Especially since interest rates are expected to remain low over the medium term.
Portfolio management
Of course, investors may wish to hold some cash over the coming months in case there’s a market crash. Doing so may provide the opportunity to capitalise on short-term mispricings among high-quality companies.
However, in many cases, stocks currently appear to include wide margins of safety. That reflects the risks they face during an uncertain period for the world economy. Buying a diverse portfolio of them now, and holding them through what could prove to be a volatile period for stock prices, may lead to high returns. And that would improve your long-term financial outlook.
