Periodic bear markets are necessary for the health of the equity markets and the well-being of investors
28-Jun-2022 •Dhirendra Kumar
Everyone hates market crashes. Not just actual crashes but even more modest bear markets, such as the one we are going through now. At least that's the impression you will gather if you just skim the financial media and social media where investors gather. Actually, I should say not everyone but almost everyone. There are many investors who are not bothered by bear markets. Not just that, there are some who actually welcome them. In fact, I count myself among the latter group. Bear markets are good, an occasional crash is good too and once in a while a really tough business environment is also good. These are things to be welcomed, not feared.
Let's see why the occasional stress is good for the markets, good for your investments and goods for business. There are a number of different reasons so let's look at them in turn.
The garbage gets cleaned out. When the markets are in a strong bull phase, or even when they are just generally doing well, a lot of froth collects on top. Companies with fundamentally weak businesses are able to create an illusion of being much stronger and their stocks do well in the markets. Punters are eager to buy anything that may trend higher soon so it's easy to boost undeserving stocks. I'm sure my readers know the whole sad story. When the markets turn downwards, these kinds of stocks get cleaned out. It happens every time. All kinds of fake tech companies got cleaned out in the 2001 bear market. In 2008, it was the turn of overhyped infra and many other sectors. This time, if the bear market runs longer, these sham new age 'digital' businesses will get wiped out. Despite the long faces you see every time, this is actually a good thing to happen. Discarding non-performers is as important a function of properly functioning capital markets as rewarding high-performers.
The good become even better. There's a hackneyed saying that 'when the going gets tough, the tough get going," but it's probably hackneyed because it's true. As we saw during the pandemic as well as earlier crises, this will undoubtedly prove to be true for many businesses. All businesses suffer in economic downturns, but the strongest ones suffer less, adapt better and recover faster. As a result, they will come out on the other side even further ahead of their competitors. Typically, the better-managed businesses react better to the crisis and make themselves even more efficient. Later, when the opportunities for growth open up, the measures they take bring a windfall. The crisis serves the same purpose that a hard training session does for an athlete.
Investors learn an invaluable lesson. When times are good on the stock markets, the froth gathers in every portfolio. Experience is the best teacher and in equity investing, bad experiences are a much better teacher than good experiences are. In fact, good experiences, unless mixed with bad ones, are likely to teach the wrong things. If one starts investing and only good times follow for a while, then one gets a distorted view of reality. One keeps investing and the money keeps growing at a fast clip and the mind tends to normalise this. You start feeling like an investing genius, and start thinking that this is the way things are going to be. And then the bad times hit. Depending on how bad they are, the shock could be small or large, or even very large. However, there's no avoiding it. It comes in the life of every investor, usually several times. Here's the key thing - unless you have been unwise enough to wipe yourself out, it always works out for the better. The basics of risk control, of diversification, of buying into only fundamentally good stocks - these things, when learned from hard experience, are never forgotten.
So all things considered, it's good that the markets are declining a bit and investors are having an uncertain time. It's like a bitter medicine that will actually bring great benefit.