Should you look for rising stocks in a falling market?

August and September are traditionally a time of crises. When stock indices are growing, not all shares participate in this movement. But when the market falls, almost everything goes into the negative. Although there are exceptions, they are so rare that they confirm the rule rather than disprove it. Andrei Lifshits, private wealth manager and author of the Telegram channel "Trends and Trades", analyzed the last 3 crises.

The worst year in the recent history of stock markets was 2008, when the US mortgage bubble burst. For several years before that, banks had been massively issuing subprime mortgages - loans with floating rates and minimal requirements for borrowers. These debts were packaged into complex derivatives that were highly rated and sold around the world.

When rates began to rise and housing prices went down, millions of Americans stopped servicing their loans. The balance sheets of the largest banks were filled with toxic assets. Lehman Brothers and Bear Stearns collapsed, Merrill Lynch had to be sold for nothing, and the U.S. government was forced to nationalize mortgage giants Fannie Mae and Freddie Mac.

This chain reaction caused the biggest financial crisis since the Great Depression. By the end of 2008, the S&P 500 had lost 38.5% - it was worse only in 1931, when the index collapsed by 47%. The technology sector suffered even more. The Nasdaq collapsed by 40.5%. Big Tech companies, which seemed invulnerable in the early 2000s, faced frozen credit markets, falling demand and massive layoffs in 2008.

For investors, this year was a test of endurance: liquidity disappeared, dividend payments were reduced, and the usual "protective" assets ceased to fulfill their role. Amid the general panic, only 4% of the S&P 500 index ended the year in the plus - 21 companies. Among them were retail giant Walmart, whose shares rose by 18.4%, McDonald's (+8.7%) and biotechnology company Amgen (+6.2%).

The probability of correctly guessing such a stock is about 1 in 20. In other words, for every company that ended the year in the positive, there were more than twenty that showed a negative result. Moreover, the "survivors" in 2008 did not demonstrate impressive growth: their profitability was modest and could hardly significantly change the final dynamics of the entire portfolio.

At the same time, the cost of a mistake was extremely high. The choice of an unsuccessful security could result in a drawdown of tens of percent - and in some cases, a complete loss of invested funds.

During the pandemic collapse of February-March 2020, the S&P500 lost more than 30% in just 23 trading days - the fastest bear market in U.S. history. In the panic atmosphere, only a handful of stocks remained in the positive: according to LSEG, only 10 companies in the S&P 500 Index rose between February 20 and March 16.

The positive exceptions were mainly some pharmaceutical and biotech companies involved in the development of tests and vaccines, as well as some retailers whose demand for their products soared in the face of the lockdowns. But even these "winners" grew unstably, periodically falling back down along with the market.

The situation turned around only after March 23, 2020, when the Federal Reserve announced unprecedented measures to support the economy: large-scale stimulus programs, the launch of unlimited quantitative easing (QE) policy and credit lines for the corporate sector. The growth started not "inside the fall", but after the official signal from the regulator.

Attempts to "catch the bottom" before that led to many problems: premature purchases ate up limits, undermined psychological stability and prevented investors from taking full advantage of the reversal. And when it did start, many had neither the funds nor the determination to increase positions. Those who were able to maintain patience, liquidity and discipline benefited the most. Unlike the classical logic of "big risk - big reward", here the risk of early entry into the market during the chaos was not rewarded.

In the first half of 2022, stock markets came under pressure from the tightest U.S. monetary tightening cycle in decades. The Federal Reserve was raising its key rate in an attempt to curb inflation, which had accelerated to 40-year highs. Rising borrowing costs have simultaneously hit consumer demand, corporate investment and stock valuation multiples.

As a result, only a small part of the market remained in the plus:

The only notable exception in Nasdaq was the pharmaceutical company Vertex Pharmaceuticals. Its quotations were supported by the news about successful interim results of clinical trials of promising drugs. However, even this "star" did not escape high volatility - during the period under review, the shares fell by more than 20% from the local maximums.

In fact, predicting the growth of this particular paper was extremely difficult: it would require not only industry expertise, but also the ability to accurately predict the outcome of complex clinical trials - a task that even specialized analysts often fail to do.

The other few "winners" showed growth not higher than 3% - a figure that cannot significantly affect the result of a diversified portfolio. Against the background of the general market decline, where mistakes in the choice of securities could cost tens of percent of losses, such a potential reward looks incommensurable with the risk. The game of "search for a winner" in 2022 was clearly not worth the candle.

All of these examples, from 2008 to recent market downturns, show that buying stocks that will rise in spite of a general decline almost always results in a loss. The probability of success is negligible, the potential benefit is limited, and the cost of making a mistake is high.

However, this does not mean that no trades should be made during a downturn. If you view drawdowns as a window of opportunity for long-term investments - in securities with fundamental value, a strong business model and sustainable competitive advantages - the approach may be well worthwhile.

The key is to evaluate a few key parameters:

Asset risk profile - are you willing to tolerate drawdowns that could last months or years?

Time horizon - how long might it take for prices to recover to levels you consider fair?

Fundamental sustainability - will the company remain competitive and investment attractive in 3-5 years?

Scenario changes - won't the market focus, industry structure or economic environment change during this time?

Equity - how much of your portfolio are you willing to allocate to such trades so as not to jeopardize your entire investment plan?

A falling market is a test not only of financial strength, but also of investor discipline. The winner is not the one who guesses the only "winner" among hundreds of falling securities, but the one who manages to preserve capital, liquidity and clarity of thinking.

Buying on a downturn only makes sense as part of a structured, long-term investment approach - when decisions are based on strategy, not on trying to outplay the market in the moment. And in this context, the key investor virtue is not excitement, but patience.

* The author is a stock market professional with more than 20 years of experience. Funds managed by him have been nominated for leading European industry awards - EuroHedge, HFM, International Business Magazine, Barclays Hedge.

This article was AI-translated and verified by a human editor