It’s been a painful start to 2016 for UK investors. Although last week did end with a recovery of sorts — the FTSE 100‘s first weekly gain of 2016 — the trend does appear to be down.
The only problem is that this correction hasn’t really been very bad at all. As I write, the FTSE is only down by around 17% from last April’s all-time closing high of 7,104. To put this in context, during the last two big bear markets, the FTSE halved in value.
That’s right, it HALVED
In both 2000/03 and 2007/09, the FTSE fell from a high of about 7,000 to a low of around 3,500.
Could this happen again?
Sadly, I don’t have a crystal ball. All I know is that historically, corrections of 15-20% are more common than multi-year bear markets. Until we see how the next six months or so play out, there’s no way of knowing whether things will get better or worse during 2016.
The last bull market, which has probably just ended, is a good example. Back in summer 2009, very few investors would have predicted that the FTSE would double in value over the next six years. But that’s exactly what happened.
The problem was that many investors stayed out of the market until most of the big gains had already happened. They then piled-in as the market approached a new high…
How to make money in a bear market
As a long-term investor, I believe the best way to make money in a market like this is simply to keep buying. This is especially true for investors like me who are still working and regularly adding money to our share accounts.
If you continue to make regular purchases, then the further prices fall, the lower your average purchase price will be. When the market starts to recover, your potential profits will also be bigger.
This is how successful professionals invest — gradually. The only thing you need to worry about is investing in large, strong, healthy companies with attractive valuations.
That means businesses with sensible debt levels, good cash generation and decent management. Big-cap companies fitting this description rarely go bust. They simply hunker down and bounce back when conditions improve. If you invest at a reasonable valuation, then you have a fair chance of beating the market in the long term.
Look at these numbers
To finish up, it’s worth considering what you can get for your money in the current market. The FTSE 100 currently has a P/E ratio of about 16 and a dividend yield of 4.2%. That seems fairly middling to me, and 4.2% is an attractive yield.
However, what if things get worse? For example, if dividends and earnings were cut by 20%, which could happen, then the FTSE would have to fall to around 4,630 to maintain its current P/E rating and yield.
I don’t know if this will happen. But even if it does, I’ll just keep buying good quality stocks for the long term. I know that eventually they’ll bounce back, and I’ll enjoy rising yields and capital gains.
Selling everything now is riskier than continuing to buy, in my opinion, because you run the risk of missing the recovery when it comes. You also miss out on valuable dividends in the meantime.
