A Lesson in Market Crashes

Be fearful when others are greedy and greedy when others are fearful. So easy to say but much harder to pull off in real-time.

The reason?

People can always become greedier or more fearful. Case in point — the Russian stock market. In early March, MarketWatch columnist Brett Arends laid out the case for investing in Russian stocks, specifically Russian small caps:

Heaven help me, I’m going to invest in Russia.

I’m not going to overthink it. I’m not going to let people talk me out of it. I am going to throw some of my money into the Russian stock market—and then forget about it for a few years.

The riskier the stocks, the better. The investment of choice looks like the MarketVectors Small Cap Russia exchange-traded fund (RSXJ), which holds stakes in about 30 small Russian companies. The fees are 0.71%.

Arends went on to show that Russian stocks were down nearly 60% from their all-time highs in 2008 at that time, while the small caps were down nearly 80% from their peak in 2007. The problem with huge losses is that it requires even larger losses to move the needle even further.

In his piece Arends showed that Russian small caps were down 78% as of the beginning of March from the all-time highs. Since then, they’ve dropped another 40%. That stings. But in the grand scheme of things that only drops the cumulative total loss to 87% in total. As the numbers approach zero (hopefully the stock market of the 8^th largest economy in the world doesn’t make it that far) you need a much bigger drop to add to the total loss. So a 40% loss only added another 10% or so to the bottom line since 2007.

To go from an 80% loss to a 90% loss requires another 50% in losses.

Unfortunately, when trying to catch a falling knife, timing can be everything. Which is why it probably makes sense for most people to either stay away from these types of speculative investments or dollar cost average over time with an established time horizon measuring many, many years.

I’m not trying to single out Arends for a wrong move here. He had legitimate reasons for taking the plunge into Russian stocks. If you read his reasons for investing in Russia, nothing has really changed all the much, except for the fact that the stocks have fallen that much further.

His thesis could still be proven out as long as he can hold his nose for a few years (or decades). The lesson here is that falling markets can always fall further than you imagine just like rising markets (see: stocks, U.S.) can stay strong for longer than most realize.

Source:
Why I’m going to invest in the Russian stock market (QZ)

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