Stock market corrections can be unpleasant to experience, but they can create a ton of cheap shares for long-term investors to capitalise on. Investor sentiment has improved in recent weeks. Yet, there are still some investors concerned about the threat of higher interest rates and slow economic growth.
For some businesses, there is undoubtedly some cause for concern. Yet, not all firms are in the same boat. There are still plenty of enterprises that, in the long run, won’t have their strategies or financials impaired by short-term economic hurdles. And successfully identifying these stocks ahead of time while they’re being undervalued by others can lead to some lucrative results with the right buying strategy.
Investing during volatility
As many investors have been reminded over the last two years, the stock market can be volatile. When fear is high, stock prices can tank overnight on even the slightest bit of bad news. This is especially true for growth stocks that typically trade at loftier valuations.
Today, the macroeconomic environment has improved significantly. Here in the UK, interest rates have seemingly stabilised while inflation is down to 4.6%. That’s still a bit higher than the Bank of England’s target range of 2% to 3%. But it’s a massive improvement on 10.1% at the start of this year.
Nevertheless, volatility is still lurking over many British stocks. And while it’s certainly frustrating to see a share price plummet from investors overreacting to short-term challenges, this behaviour can be leveraged to work in favour of long-term investors.
A sudden unjustified drop in the share price of a high-quality company creates a buying opportunity. And as every investor knows, buying low and selling high is the ultimate recipe for building wealth in the stock market.
Of course, it’s near impossible to predict what’s going to happen in the next few weeks or even months. Therefore, throwing all my capital in one giant lump sum may leave a lot of money on the table if shares continue to slide in the near term.
Instead, it may be far wiser to steadily drip-feed money into top-notch cheap shares over time. That way, if a better price emerges, investors can capitalise on them, bringing the average cost per share down and pushing the potential returns up.
Nothing is guaranteed
It goes without saying that investing is far from risk-free. Just because a stock has performed well in the past doesn’t mean it will in the future.
Today’s macroeconomic environment is vastly different from the last decade. The cost of borrowing money is significantly higher. And businesses that have grown reliant on debt financing to fund operations are in for a rude awakening.
Even some of the biggest companies on the London Stock Exchange are starting to feel the pinch. And in many cases, debt reduction is now at the top of the priority list.
All of this is to say that while a rapid decline in market capitalisation might look overblown, it might, in fact, be justified. Investors need to carefully examine each opportunity carefully, exploring both the bear and bull case. Otherwise, they may find themselves being lured into value traps.
