At the time of this writing, the Nasdaq Composite (NASDAQINDEX: ^IXIC) is down 9.4% from its 52-week high, while the S&P 500 (SNPINDEX: ^GSPC) is down 6%.
While we are nowhere close to a full-blown market crash, the Nasdaq is close to correction territory, which is a drawdown of at least 10%. A crash is usually defined as a swift sell-off of at least 20%, and a bear market is a prolonged decline of more than 20%.
No one likes losing money. But stock market sell-offs and bear markets can present tremendous buying opportunities for long-term investors.
Here’s how to navigate a sell-off, and how you can use periods of pessimism to build lasting generational wealth.
Economist Benjamin Graham, author of the 1949 book The Intelligent Investor, famously wrote: “In the short run, the stock market is a voting machine. But in the long run, it is a weighing machine.”
This means that short-term movements in stock prices have nothing to do with a company’s intrinsic value. They’re merely representative of whether the stock is in or out of favor.
During bull markets, investors are optimistic and may be willing to pay a higher price based on a company’s growth potential. During bear markets, investors are pessimistic and want to pay less for a company based on its value or potential.
The key is to invest in fundamentally sound businesses that can grow over time, rather than using a stock’s price as a yardstick for whether it is worth buying and holding or not.
In a bull market, both good and bad companies see their stock prices go up. But in a bear market, even the best companies can sell off simply because their near-term outlook is weak.
In his book The Psychology of Money, Morgan Housel discusses the importance of knowing what game you’re playing. He describes the stock market as a field upon which multiple games are being played simultaneously. There are traders versus investors, institutions and individuals, risk-tolerant folks with ultra-long-term time horizons, and retirees looking to preserve capital and generate passive income.
All these factors are at play and can pull the market in different directions. A stock can stay beaten down for an extended period simply because traders don’t think it will do anything in the near term, and then suddenly rocket higher once the narrative changes.
In comparison, some stocks can become Wall Street darlings and fetch consensus favorable ratings from analysts, which can stretch their valuations. As Warren Buffett famously said: “You pay a very high price in the stock market for a cheery consensus.” This means that if a stock is well known and liked, chances are it isn’t going to be cheap.
