US vs the Rest of the World
On April 2, Donald Trump unexpectedly announced high tariffs on almost all countries based on a flawed understanding of maths and economics. Compounding the bad news is the fact that the tariffs were to be effective in just a few days. This translates to an immediate cost spike of 10% to 50% for US companies importing goods from anywhere in the world.
The importing US company would ask the foreign exporters to shoulder some of the costs by lowering their selling price. However in a typical supply chain, the producers of goods have lower profit margins than the final retailer selling to the consumers. Think of cloth producers in low cost countries vs Lululemon that sells jogging pants upwards of $70 simply by slapping on its logo. This means the foreign exporters will simply be unable to lower much of their selling price.
The US importer now needs to decide how much of the additional cost it can pass on to its customers without causing the customers to stop buying its products altogether. If it doesn’t have the profit margins to absorb whatever is the remaining costs that it cannot pass on, the company will soon go out of business.
Through this simple logic, the market saw doom for US companies. The US tariffs will hurt US companies more than the companies selling to the US. The US stock market plunged into a bear market with more than 20% decline from its peak in February. Markets elsewhere also declined but the US market took the brunt of the hit. It was a remarkable “harakiri” by Donald Trump.
Investing during a Down Market
During periods of extreme market volatility, it’s important to zoom out and take a long term view of the situation. On average, the US market has a correction of at least 10% every 2 years and a bear market of at least 20% every 6 years. In the dot-com bust of 2000 and the global financial meltdown of 2008, the S&P 500 ultimately fell 50% from its previous peak. In Malaysia, the KLCI crashed 80% during the 1997 Asian Financial Crisis and did not recover for a decade.
Even though it’s easy to see the crash when it happens, it’s much harder to know how deep and how long it will last. A 20% drop does not mean it will not eventually drop by 50%. It can be all over in a few months or it can continue to drop for 1 to 2 years. After that, the market can, and usually will, take a much longer time to recover.
The key to wealth building is to invest for the long term and harness the power of compounding returns. Therefore, the best strategy during bear markets is to simply ride it out and continue investing as assets become cheap during these periods. Remember, over a period of time, markets tend to be better and not worse.
It is also important to stay sane throughout the whole episode of downturn and eventual recovery. As Warren Buffet said:
The stock market is designed to transfer money from the active to the patient
Warren is known for always keeping cash or cash equivalents handy that can be quickly deployed when the best business deals avail themselves. In good times, keep aside enough cash for monthly expenses and emergencies. At the same time, build up a percentage of your funds in cash equivalents (eg in money market) that can be drip fed into the crashing market. Just as no one knows how long a downturn can last, take your time when deploying your hard earned funds into the market.
The Finance Durian 