Economic Crises

Economic Crises

Economic Crises

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Major economic crises can be particularly scary events, but they represent the mother lode for investors who have the courage and knowledge of their individual stocks to take advantage of the crisis.

The stock market often reacts strongly to macroeconomic crises. Many investors suspend their forecast of future progress for their companies. During these events, many investors believe that the future value of their stocks has declined. We think that those investors who sell during these times are making a predictable and catastrophic mistake. The future value of a company is more dependent on its management decisions and its industry conditions than it is on the general economy. But the massive press coverage of economic problems tends to override our sensibilities. So we ignore what is important and focus on what is not.

In the case of most major crises, the crisis occurs at the end of the problem—not the beginning. The crisis actually initiates the process of repairing whatever problem created the crisis.

There is another, more serious risk associated with the aftermath of a macroeconomic crisis. Investors are diverted from their fundamental task of analyzing and identifying great investment opportunities when they attempt to analyze the repercussions of an economic crisis. Since you can’t analyze the implications of an economic crisis effectively, why waste your time trying? In times of economic crisis, investors need to focus on their true objective, which is identifying and analyzing great stocks for their portfolio.

As stock market investors have learned, an economic crisis typically causes an almost universal decline in stock prices. For astute investors who can quell the butterflies in their stomach and concede that they cannot predict the outcome of the crisis, the crisis presents an outstanding opportunity to improve their investment position.

In 2008, major U.S. banks and other financial institutions around the world collapsed. Fannie Mae and Freddie Mac were put into receivership. Lehman Brothers and AIG collapsed, raising a very real possibility that the world’s financial system would implode. No one could confidently predict whether the system would hold together.

The U.S. stock market responded by declining more than 50 percent from its peak in 2007. The stocks of many fine companies declined even more. Investors faced a very clear choice: focus on the economic travails (the resolution was unpredictable), or focus on the many fine companies whose stocks were selling at bargain-basement prices. At the market lows of 2008 and early 2009, stock market investors had very high odds of exceeding their hurdle rates. For astute investors, 2008 and 2009 represented a once-in-a generation buying opportunity.

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Source

Benjamin Graham and the Power of Growth Stocks,

Frederick K. Martin,