Renowned stock market investor and fund manager, Peter Lynch, once said:
You get recessions, you have stock market declines. If you don’t understand that’s going to happen, then you’re not ready. You won’t do well in the markets.Peter Lynch
Let’s try to understand what he means by the quote.
The economy, businesses, stock market and most other things in life.. work in cycles.
What goes up has to come down and the once things hit rock bottom, the only way it can go is up.
In the quote, Peter Lynch says, economies will go through recessions – like the global recession that we are going through right now, due to corona-virus.
When economies are going through recessions, stock market declines are inevitable. It cannot be avoided.
Hence, if you do not understand that recessions will happen and the stock market will decline – then you aren’t psychologically (or mentally) ready to invest in the markets.
And since psychology is such a big part of the market, if you aren’t mentally conditioned to sustain the ups and downs (volatility of markets) – then you don’t do well.
In other words, when the markets decline – there is a lot of negative news in the media, which is accompanied by fall in stock prices. The fall is always faster than the rise.
This creates extreme fear in the market, no one really knows where the bottom is.
If the ‘NIFTY’ falls from 12,000 to 6,000, it can also fall another 50% to 3,000. When the market is crashing, investors are usually extremely pessimistic and expecting things to get worse.
One of the world’s most successful investors, Warren Buffet, also said something which meant the same – “Unless you can watch your stock holding decline by 50% without becoming panic-stricken, you should not be in the stock market”
Both quotes mean the same.
The market could crash because of any reason.
China could declare a war on India. There could be a political collapse. There could be another virus like Covid, which has already done a lot of damage globally.
Just like life itself, the stock market is also full of uncertainties. Anything could happen anytime and unless you are prepared for large draw-downs in your portfolio, you should not be invested in the market.
A few other points worth remembering:
- The market and economy may not move in the same direction. At the time the economy is peaking, the market could already be falling.
- At the same time, the economy could be struggling and the market could be continuously rising. This is because the market predicts (or prices-in) the future. This is what is happening today – the world is struggling with Covid, but markets are rising everyday.
This happens at stock level too. A classic example is Maruti Suzuki.
The share price of Maruti peaked between the beginning of January to around the end of August in 2018.
From September 2018 onwards, the share began its downfall. The sales were steady, but the stock price was crashing.
The year-on-year fall in sales numbers only came in May 2019, but then the stock had already crashed 30%. The steady fall continued.
Now, the sales are getting poorer, but the price has begun to rise – what does it suggest? Is the market pricing-in a recovery 1 year from now? Only time will tell, but in most cases – that’s how the market behaves.