I recently opened my fading copy of David Dreman’s Contrarian Investment Strategies and flicked through to the chapter with the heading Crisis Investing.
Dreman became known for his success as a contrarian investor and penned several books about the subject. He wrote: “A market crisis presents an outstanding opportunity to profit because it lets loose overreaction at its wildest.”
Are the share price falls justified?
Guidelines of value disappear in a crisis, he argued, and people no longer examine what a stock is worth. That implies, of course, that share prices tend to overshoot to the downside. And Dreman’s advice is to go against the crowd and buy shares in a crisis, arguing that one or two years later you will probably be glad you did because they may have gone up a fair bit.
He reckons that the market “always” considers the crisis to be something new. But if you analyse the reasons put forward to support lower share prices, “more often than not, they will disintegrate under scrutiny.”
And indeed, we’ve seen some quite big bounces back up over the past few days by the main market indices, such as the FTSE 100, and from some shares such as BP, HSBC and Ferguson and many others. However, other shares are less buoyant, such as Vistry and Compass.
It’s always tempting to try to compare the market to previous crises. Studying the charts from the time of the 1918 flu pandemic could lead us to believe that the markets may have already bottomed-out during the current coronavirus crisis. Indeed, the general market has already fallen roughly as far as it did back then.
The stock market looks ahead
And a century ago, the markets recovered before the effects of the virus pandemic peaked, which makes sense because the stock market always looks ahead and tries to anticipate economic recovery.
However, general economic conditions were different back then. The world was still engaged in the Great War and supply chains in the economy were already barely functioning. A virus pandemic arguably couldn’t damage an already-broken system as much as it can today’s sophisticated set-ups.
Maybe this time around we will experience something more comparable to the stock market crash of 1929 and the great depression that followed. Let’s hope not, because from August 1929 until March 1933 the S&P 500’s total return was around minus 75%. However, stocks were regarded as being over-valued prior to the crash. Although some have been making a similar argument about US stocks prior to the current setback in the markets.
One thing seems assured – more volatility! Dreman reckons you need to go into crisis investing with your hard-hat on. And he recommends diversifying across several shares in case you pick up a duff one that fails to recover.
As well as diversifying across quality shares, I’d handle investing in today’s stressed stock market by drip-feeding money into managed and tracker funds. Collective investments like those will provide you with instant diversification across many underlying shares. Meanwhile, a regular investment programme would help you avoid too much pain if the markets do end up going lower from where they are today.
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Kevin Godbold has no position in any share mentioned. The Motley Fool UK has recommended Compass Group and HSBC Holdings. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.