Stock Market Lessons from the Last 2 Years

We've been living through surreal times since the 2020 pandemic. While the word "unprecedented" often gets thrown around when describing the events of the last 2 years, if we look through history, we can find patterns. So truly, we are living through precedented times.

However, there are some lessons that we can learn from the last 2 years if we take a moment to reflect. You know what they say; the patterns become clear in hindsight. Here are 12 lessons I've got from the stock market.

Lesson 1: Investors are evanescent

Evanescent, soon passing out of memory; quickly fading or disappearing - Google dictionary

Investors get too comfortable too quickly. When uncertainty strikes, they get angsty for too long till things settle down again, and then they get comfortable till the next uncertainty strikes.

Massive uncertainty struck in the form of the 2008 financial crisis.

To get things to settle down, governments in the developed world lowered interest rates to historically low levels and pumped a lot of money into their economies through quantitative easing.

Quantitative easing?(QE) is when a?central bank?buys?long-term securities?from its member banks. By buying up these securities, the central bank adds new money to the economy

When we got on our feet post the 2008 financial crisis, share prices of growth companies began a decade long bull run. We started to get comfortable. There were corrections in between, but overall, markets were good for profitable and unprofitable "growth" companies.

Investors quickly forgot that eventually, central banks would need to raise interest rates and stop artificially flooding the markets with money.

In December 2018, alongside the US-China trade war, it looked like the US Fed was going to raise interest rates. Enter uncertainty, stocks dropped.

The Fed kept steadily raising interest rates till COVID struck. Enter another uncertainty.

Central Banks needed to step in again to cut rates, and many governments injected stimulus into their economies. Kicking off an even larger bull run with stocks hitting all-time high after all-time high.

Since interest rates were so low, there were minimal investment opportunities that made sense to make outside of stocks. Due to a crisis of no alternatives, even more money flooded into risky assets.

As more money chased risky assets like stocks and crypto, these caused those asset prices to be highly inflated. However, companies were not inherently worth more; there was just more money chasing stocks.

Even if you are not ready for the day, it cannot always be night

The money printing machine had to stop at some point, right? And that it has. Now Central Banks have to raise rates. Enter uncertainty again.

Lesson 2: Being too early can be just as bad as being too late

Imagine how much money anyone who shorted Tesla shares in 2020 lost. Imagine how much money they would have made if they shorted Tesla shares in just the first half of 2021. That's the price of being too early.

It is almost impossible to time the end of a bull run. Loads of people felt stocks and crypto were overpriced by the end of 2020, but that didn't stop those assets from soaring in 2021.

Anyone who predicted the bursting of the stock market bubble by the end of 2020 probably looked silly till November 2021. Anyone who had been saying asset prices are overly inflated due to incredibly low-interest rates also probably looked silly till recently.

If they invested with that mindset, they would have lost money for a while. Being too early can be just as bad as being too late.

Lesson 3: No industry is "over" just yet

Over the past 2 years, we've seen industries that people wrote off making massive comebacks. Anyone invested in oil companies was bleeding in 2020, but in 2021 they were smiling to the bank. The most popular person everyone likes to dunk on is Cathie Wood, who said oil prices would slump to $12 and not recover. That aged well...

Non-ESG friendly sectors like Defense were considered a no-go area to invest in, but over the last few weeks, some of them have made a comeback. Commodity prices had a great run. Nickel, for example, hit a 10-year high so much so that the London Metal Exchange had to freeze prices after a while.

Several out-of-favour companies have made massive comebacks in the last 2 years. Could this be an argument for staying invested and averaging down if your investment falls? Or is it all a gamble?

Lesson 4: Betting may not be so different from investing in the stock market

Ironically, the subreddit that birthed the Gamestop mania of 2021 is called "Wall street BETS".

The key difference between betting on stocks and betting on a football match is that investing in a company creates some value. It is buying into their growth story. Although most of the trading that happens in the secondary market doesn't add any money to the company, they can still benefit from what the stock market currently values their companies at if they raise money from capital markets. But betting on a match doesn't bring much value beyond the excitement of seeing Messi score goals on the pitch.

However, over the last 2 years, we have seen companies rise to insane valuations without generating this additional value we speak so highly of.?So could that be gambling then? Or are investors simply voting?

Lesson 5: Investing is voting with your money

Looking at it further, you can see the stock market as investors putting their money where their mouth is, where more money equals more voting power or a large voting bloc. When a company like Tesla is added to the S&P 500, that is a lot of money voting for it, thus raising the price significantly.

However, as we know, democracies are ultimately popularity contests where unpopular but true opinions may lose. So what happens when large capital votes wrong? Or rather, what happens where there's so much capital voting that it inflates values beyond what they should be? The answer, markets move on.

Lesson 6: Markets move on before everyone else

This is why economists look to the market as a leading indicator of where the economy is going. If markets sense that they wrongly assigned value to a company, they punish quickly and harshly. See cases of stock prices dropping over 70% in a few months. And since markets claim to always be forward-looking, they can look like they are detached from reality.

Look at the Russia-Ukraine invasion. Markets assumed that Russia was pulling out, so stocks jumped in Feb. That proved false, so stocks tanked, oil prices soared. Today, the US is considering releasing shares from oil reserves, oil prices dip. If the US cancel that decision, oil prices will soar again. Just quickly responding to information and pretending to look at the bigger picture but are they really?

Lesson 7: Is the stock market more efficient now, or are we being quixotic?

Quixotic, extremely idealistic; unrealistic and impractical - Google dictionary

Over the last 2 years, we've lived through at least 3 stock market crashes. 1st when we went into the pandemic, in November when it started becoming clear that inflation was not transitory, and again when Russia invaded Ukraine. But unlike all other crashes in history that take on average 18 months to several years for markets to recover, markets bounced back in anywhere from weeks to less than a quarter.

PS: most stocks are still down 40-50% since November. Could that be another dot com crash?

This begs the question, are markets more efficient? An efficient market, among several other things, can take information, process it quickly and adjust the valuations of companies. So if markets can quickly take information, adjust valuations and within days come to a consensus on where the right price is for companies, aren't they more efficient?

It's hard to say since many of the improvements we've seen in the markets are still artificially driven by lots of money in circulation and low rates.

Lesson 8: Markets hate uncertainty, but that's where the best opportunities lie

Capital markets hate uncertainty. If ultimately, we should aim to invest in things we understand, any uncertainty would mean that we can't fully understand an opportunity, and as such, we shouldn't take it.

However, the age-old saying "Be fearful when others are greedy and greedy when others are fearful" reads through here. The best buying opportunities lie when everyone is running away from good businesses due to temporary uncertainty, and the best selling opportunities lie when people are too comfortable.

But remember, if you're too early, you could lose big, which brings me to the next lesson.

Lesson 9: When you lose big, you need to win even bigger to breakeven

A sharp drop in the value of your investments, as we saw in March 2020 when the S&P 500 plunged 34%, can take a significant amount of time to recover from, even when the market quickly rebounds. That's because recouping market losses requires a disproportionately higher percentage gain to return to breakeven.

For example, let's say you lost 20% on an investment of $100. The value of that investment would drop to $80. A subsequent gain of 20% would only bring the value of the investment to $96, not the $100 you started with (20% of $80 is $16). To get back to the $100 you started with would require a 25% gain.

And remember, that only gets you back to breakeven. Depending on market conditions, it can take weeks, months or even years to recoup stock market losses.

Lesson 10: Let your winners ride but take some chips off the table before you lose it all

You might be tempted to sell when you see stocks hitting new high after new high. But we all know the story of someone who sold (insert name of a popular asset here, e.g. Bitcoin) before the price soared and missed out on more money if only they had waited.

However, we don't want to sit on our profits for so long till the bull market ends and stocks drop 40%, and we're left waiting for years to get back to where we were before. So the strategy is to take some profit off.

You can choose to hold the cash and reinvest if asset prices drop, invest elsewhere to diversify or spend the money.

You only take some chips off the table, so you don't lose your gains, and if the asset keeps rising, you don't miss out on future gains.

How much should you take off? There's no rule but if you've doubled your money, perhaps taking out the capital might be a good start. Or, if you've made a 50% gain, take the gain off and leave the capital.

Lesson 11: Everyone is a genius during a bull market

See how Cathie Wood was praised in 2020 as one of the smartest investors of her time vs how her investment predictions are being ridiculed now.

If you bought growth stocks in March/April 2020, you were probably feeling like a genius by the end of the year. However, if you're still holding some of those stocks that are now down 50% or more since last November, you might be thinking differently.

You're not right because your portfolio is green or wrong because yours is red

When the stock market is hitting new high after new high, it's easy to follow the wave and make money. But skill and discernment show more when the easy money stops.

Final Lesson: Patience is Crucial

When you invest money you don't need for years, it changes the game. You can take a longer-term approach. Look for the great businesses that maybe people aren't looking at yet. You can afford to be too early on some. Being patient is the difference between recording a 20% and a 30% profit. It's also the difference between 30% profit and 3000% profit.

What lesson has the stock market taught you these past few years?