It seems that every 3-4 years, somewhere in the world has a massive economic crash and/or bear market. I was thinking, what would be the potential rewards of investing *only* in places where a complete rout has occured.
To give some examples from recent years:
i) Asian stocks, Russian stocks, oil, and other commodities in 1998
ii) Argentina and Brazil in 2002
iii) World stocks in 2002-2003
iv) G7 real estate in 1993-95
v) Gold in 1999-2001
vi) internet stocks after the bubble
Although you can say there's an element of hindsight bias, in each of these cases the market in question was i) very cheap fundamentally ii) suffering extreme negative sentiment and media coverage iii) had fallen by very large % amounts relative to typical historical declines and iv) in many cases, there were significant reactions to the large price declines (e.g. street riots in Argentina in 2002 and Indonesia in 1998; Bank of England selling its gold, then the central banks limiting gold sales; OPEC restricting oil production in 98/99.) Furthermore, in each of these cases, the markets subsequently had very large rallies indeed in the following years. The rally frequently lasted at least 12 months after the bottom was in, and often went on longer.
So I was wondering to what extent it would be feasible to invest major amounts only in markets which have had a huge crash, are dirt cheap, and would be trading at much higher levels once just "normal" valuations return. If we try to characterise these moves by looking at previous occurences, we find that:
i) they have really massive declines before the lows are put in (e.g. 75%+ for stock indices, 50%+ for commodities, 80-90%+ for sectors, 95%+ for individual stocks)
ii) they are incredibly cheap at the lows by all fundamental measures
iii) sentiment is incredibly bearish, very few people stick their necks out and call for any rally at all, let alone a massive multi-year rally
iv) the lows usually coincide with some major "bad news" event
v) the subsequent rally usually lasts at least 12 months, and often goes on for many years. Generally it rallies far more than expected.
vi) there are often a couple of sharp corrections during the subsequent rally (e.g. 15-25%), but the market bottom is never violated once the rally gets underway, and each correction low tends to hold once the market has rallied back.
vii) once the rally begins in earnest, few people are in on it, and it takes a long time before sentiment becomes genuinely bullish again
viii) the rally usually tails off once "bullish" signs appear, both in terms of fundamentals and sentiment
It seems to me that identifying the cheapness is not that difficult - rather, the main risks are i) getting in too soon ii) getting panicked out during the height of the crash/crisis iii) selling too soon during the subsequent rally. This kind of approach would seem ideal for dollar-cost averaging, since the exact timining is difficult, and possibly for playing with long-dated call options once the lows appear to have been put in, since the subsequent rallies are very large and long-lasting.
What are you thoughts on how feasible this approach is, how to play it, what techniques to use, and what the potential returns are?
To give some examples from recent years:
i) Asian stocks, Russian stocks, oil, and other commodities in 1998
ii) Argentina and Brazil in 2002
iii) World stocks in 2002-2003
iv) G7 real estate in 1993-95
v) Gold in 1999-2001
vi) internet stocks after the bubble
Although you can say there's an element of hindsight bias, in each of these cases the market in question was i) very cheap fundamentally ii) suffering extreme negative sentiment and media coverage iii) had fallen by very large % amounts relative to typical historical declines and iv) in many cases, there were significant reactions to the large price declines (e.g. street riots in Argentina in 2002 and Indonesia in 1998; Bank of England selling its gold, then the central banks limiting gold sales; OPEC restricting oil production in 98/99.) Furthermore, in each of these cases, the markets subsequently had very large rallies indeed in the following years. The rally frequently lasted at least 12 months after the bottom was in, and often went on longer.
So I was wondering to what extent it would be feasible to invest major amounts only in markets which have had a huge crash, are dirt cheap, and would be trading at much higher levels once just "normal" valuations return. If we try to characterise these moves by looking at previous occurences, we find that:
i) they have really massive declines before the lows are put in (e.g. 75%+ for stock indices, 50%+ for commodities, 80-90%+ for sectors, 95%+ for individual stocks)
ii) they are incredibly cheap at the lows by all fundamental measures
iii) sentiment is incredibly bearish, very few people stick their necks out and call for any rally at all, let alone a massive multi-year rally
iv) the lows usually coincide with some major "bad news" event
v) the subsequent rally usually lasts at least 12 months, and often goes on for many years. Generally it rallies far more than expected.
vi) there are often a couple of sharp corrections during the subsequent rally (e.g. 15-25%), but the market bottom is never violated once the rally gets underway, and each correction low tends to hold once the market has rallied back.
vii) once the rally begins in earnest, few people are in on it, and it takes a long time before sentiment becomes genuinely bullish again
viii) the rally usually tails off once "bullish" signs appear, both in terms of fundamentals and sentiment
It seems to me that identifying the cheapness is not that difficult - rather, the main risks are i) getting in too soon ii) getting panicked out during the height of the crash/crisis iii) selling too soon during the subsequent rally. This kind of approach would seem ideal for dollar-cost averaging, since the exact timining is difficult, and possibly for playing with long-dated call options once the lows appear to have been put in, since the subsequent rallies are very large and long-lasting.
What are you thoughts on how feasible this approach is, how to play it, what techniques to use, and what the potential returns are?
