Should I invest during a stock market downturn?

The story of ‘Joe’

We have all heard the average Joe tell stories about their intelligent investment that reaped stellar returns. However, it’s fair to say that we rarely, if ever, hear about their sharp losses.

When the stock market goes up and only up, everybody thinks they’re tantamount to Warren Buffet and that they know everything about investing. However, without a financial education, these same people lose most of their paper profits when the tide turns against them.

As legendary investor Warren Buffet once said, "You should buy when there is blood on the streets." While this is a great advice, it can be really difficult to decide what to buy.

Why a stock market downturn occurs

In the long-term, when demand for certain types of commodities and services picks up, companies involved see their stock prices increase. However, as global growth has stagnated over the last year, markets have really suffered.

There are also macroeconomic factors that are dragging the global economy down, such as China’s slowdown, slow European recovery, uncertainty on US Fed’s interest rate decisions and the crash in crude oil prices. However the slowdown itself doesn’t mean that there are no investment opportunities.

For instance, earlier this year ASX 200 – an index representing Australia’s leading companies – crashed over 15% during six months from April to September. During the same period of time the Nifty 50 – India’s index of leading companies – dropped around 1%.

The aggravated impact on the Australian market was on account of its concentration on financials, materials and industrials, industries that constitute almost 70% of ASX 200.

Currently, key macroeconomic uncertainties, such as commodities, demand and monetary policy of large economies are among the major risk factors for these sectors.

The disruptors

There are always disruptive companies and technologies that are not reflected in a country’s stock market during their early stages. A few top of the pyramid examples are social media companies Facebook and Twitter, which are now bellwethers of the technology sector.

A similar trend was seen in cyber security – when hacking received global recognition as being a serious threat, stock prices of companies such as CyberArk and Palo Alto Networks skyrocketed. The adjacent chart highlights that both companies could achieve steep revenue growth.

A couple of popular disruptors expected to go public in near future are Uber, Dropbox, SpaceX and Surveymonkey. These companies can be great investment opportunities, irrespective of weak economic outlook, as they change the way an industry operates.

The victims of herd mentality

Despite experts and financial media trying to figure out logical reasons to explain Australia’s the poor economic performance, there are attractive investing opportunities when a broad view of the economy is considered.

However, it’s important to recognise that the outlook for Australian companies operating in the resources sector and capital goods remains gloomy on account of China’s slowdown, the largest commodity trader in the world.

Blue-chip companies that operate in sectors that have minimal, or negative, correlations with dominant negative macroeconomic factors, also become significantly undervalued during a market selloff.

For example, the low-interest rate environment and robust construction cycle provides a great opportunity for people to invest in the Australian housing sector.

As of 31 October 2015, ASX 200 Listed Property Fund was up 12.97% for the year compared to a 13.27% decline in ASX 200 Resources Fund.

Black swans of investment

Even in the Australian mining sector, which is decidedly undergoing a downturn, there are black swans; companies that take us by surprise. This is evident in the chart above, which depicts the company Syrah Resources as poised for tremendous growth.

Recently Syrah Resources, a Melbourne-based mining company, signed a sales and marketing agreement with a premier Chinese producer of coated spherical graphite. This resource is required to meet China’s unfathomable lithium ion battery demand.

With a diversified exploration portfolio in Northern Mozambique, Syrah sits on the largest graphite resource in the world. The company has completed the feasibility study and is preparing to kick-off production, and is expected to benefit from the Chinese auto industry’s shift towards electric cars.

Conclusion

A stock market downturn, which generally causes panic among investors, can be turned into an opportunity to make highly successful long-term investments.