Why Economic Downturns Are Great Investment Opportunities
Equities are down, and with the Federal Reserve combating inflation using quantitative tightening, there is a good chance they will see more market downside. If you have job security and are making enough money to stow expendable cash, economic downturns are actually great investment opportunities.
That isn’t to say you should go all-in with everything you have today (and this post is far from financial advice). But when markets correct, it can be a great time to buy an asset you believe in at a better price than you could when markets are hot.
But why?
What Happens During A Recession?
The basic definition of a technical recession is two consecutive quarters where the GDP experiences negative growth. The economy contracts as a whole, even if certain sectors are experiencing growth. But this definition is a bit nebulous.
Investopedia has a more straightforward explanation of what a recession is.
“Recessions are, in essence, a cluster of business failures being realized simultaneously. Firms are forced to reallocate resources, scale back production, limit losses, and, usually, lay off employees.”
This cluster of business failings causes a significant reduction in spending across all sectors of the economy and affects employment, industrial production, commerce, retail trade, and wages.
How Prices In The Stock Markets Reflect The Health Of The Economy
During periods of economic growth, there is a market euphoria that causes investors to invest more and more. In euphoric market states, individuals and businesses take on riskier loans because interest rates are (usually) low, and financial actors are willing to lend more money to riskier debtors.
This euphoria is part of basic market psychology. When people have money to invest in businesses they believe in, it helps to inflate the value of those businesses.
In this euphoric market environment, asset bubbles begin to emerge. Basically, when an asset’s actual value is far below what people are willing to pay for it, it is in a bubble. Any asset, including stocks, digital assets, and real estate, can become overvalued.
Asset bubbles and market euphoria are two reasons why human psychology plays a fundamental role in market action. When things are good, they tend to get really good. When bubbles grow too large, they tend to pop.
Bursting Bubbles In The Stock Market Are Leading Indicators
The stock market also acts as a leading indicator of more significant economic troubles. The recent crash of the S&P 500 into bear market territory shows that there is currently a lot of fear running rampant through many markets.
Investors realized that record-high stock prices resulted from rampant inflation and a stark reversal of the loose policy of quantitative easing from the Fed.
Recently, the price of commodities like food and oil started to skyrocket as macroeconomic crises like global supply chain issues, a war in Ukraine, and an impending burst of international real estate bubbles began to weigh heavily on the minds of market actors.
Currently, panic is spreading like a contagion through many sectors as investors pull their funds out of the stock market and move to cash or more secure assets. Yet, it is this price reset that presents a great economic opportunity for people who have some expendable income.
Bear Markets Are The Time To Build
Most investors are familiar with Warren Buffet’s now-famous quote in a New York Times article from October 2008.
“A simple rule dictates my buying: Be fearful when others are greedy, and be greedy when others are fearful.”
When prices reset and bubbles burst, it allows investors to buy assets at a discount, or at least closer to their actual value. The price of an asset and an asset’s actual value are absolutely not the same thing.
Don’t Conflate Price and Value.
Think of a Pokémon card. The price is easy to quantify—look on eBay for what a rare 1st edition Charizard card is going for. Recently, a 1999 1st edition Charizard card sold for $420,000 at the PWCC March Premiere Auction earlier this year. $420,000 was the price of that asset at a particular moment in time. Its price was once 20 dollars.
But what’s its value? How can you quantify value? In the current version of the Pokémon Trading Card Game, the card is pretty worthless—it’s not very effective. As an actual piece of cardboard, it is effective. From a collector’s point of view, the card has value, but its value is tied to its scarcity and the mythology behind Pokémon.
The lesson here is to never overpay for an asset. When stock prices fall sharply due to a massive correction—like we are seeing now—it presents an opportunity for investors to get back into the markets at a lower price.
If there is one truth to market psychology, it’s that it swings like a pendulum. There will be another period of market euphoria at some point in the future. But you don’t want to buy in at the top. Instead, you want to buy when prices are low.
How Do You Know When It’s A Good Time To Buy?
Nobody has a crystal ball. This article is not meant to be financial advice. Rather, it encourages the reader to learn more about long-term investing strategies. The investors who bought into the S&P 500 directly after the 2009 market crash rode up a 10-year bull run and experienced a 524.90% ROI.
How Can You Tell When The Markets Have Bottomed Out?
The short answer is that you can only know in hindsight after the markets bottom. But there is a useful strategy to average out your entry price. Dollar-cost averaging is an investment strategy where you buy a set amount of an asset at regular intervals of time, no matter what the price is.
For example, one week, you bought $100 worth of an asset when it was valued at a 1:$1000 ratio. The following week prices went down, and you purchased $100 worth of the same asset when it was valued at a 1:$950 ratio. Over time, this strategy averages out price volatility.
Our Unique Inflation + Quantitative Tightening Situation
Right now, the US economy is experiencing high levels of inflation, the likes of which we haven’t seen since the early 90s. This is adding to the weight of our current economic crisis. The coming recession will likely not be quick and easy. But it might offer eager investors a chance to better their positions for the next bull cycle. Take this downtime in the markets to learn and build.
About the Author
Jenn Walker is a freelance writer, blogger, dog-enthusiast, and avid beachgoer operating out of Southern New Jersey. She writes for First National Realty Partners, a private equity real estate investment firm and educational resource that covers everything from 1031 exchanges in commercial real estate to portfolio diversification strategies.
*This is a collaborative post.
