After some tough weeks, the stock market rebounded last week in a powerful rally that saw U.S. stocks post their best week since November 2020.
While we have no way of knowing whether this is the start of a sustained recovery or just a pause in a longer correction, there are some valuable lessons we can draw from recent market action.
First, we see once again just how quickly things can turn around. After a seven-week losing streak that brought the S&P 500 briefly into bear market territory when it fell below 20%, the U.S. index rallied 6%[i] last week.
Again, we don’t know what the future holds, but this was another example of how fast new information and/or changing investor perceptions can cause a reversal in the market.
Second, this year’s correction has confirmed that building wealth is not about hitting home runs. It’s about avoiding big mistakes.
The pain of losses in both the stock and bond markets this year has been real for long-term investors, but it pales in comparison to what’s happened in the most speculative corners of the financial markets.
Formerly hot markets for assets such as crypto-currencies, special purpose acquisition companies (SPACs) and tech stocks have all seen devastating crashes this year.
Many investors piled into these kinds of investments during the pandemic, encouraged by rock-bottom interest rates, media hype and apps that allow commission-free trading with the push of a cellphone button.
This year has been particularly disastrous for crypto investors. Bitcoin has lost more than half its value from its peak in November – a crash that featured a market panic when a number of so-called “stablecoins” broke their peg to the U.S. dollar. And it hasn’t been just Bitcoin – the value of all cryptocurrencies stood at $1.3 trillion last week, down from $3 trillion in November, according to Reuters.
Among the hopes for Bitcoin that have been dashed by this downturn is the idea that it’s a good hedge against inflation.
SPACs are another formerly high-flying market that’s come crashing back to earth. A SPAC is what’s known as a blank-cheque company. Investors buy shares in an IPO and then the sponsors of the SPAC go out and find a company to buy with the cash they’ve raised.
The market for new SPACs has dried up, and high fees and heavy share dilution have taken a heavy toll on the companies that had already emerged from SPACs.
According to this article, “the more than 300 companies that have gone public via SPAC mergers since the start of 2018 have averaged a loss of about 33% from the IPO price, versus an average loss of 2% for the 1,000 other companies that chose to go public through a traditional IPO as of mid-April, according to Renaissance Capital, which tracks IPOs.” Those disastrous results compare to a more than 50% gain for the S&P 500 during the same period.
The picture has also been grim in the world of tech. The same combination of worries that have hit the wider market – high inflation, rising interest rates and geopolitical uncertainty – has been much harder on the market fortunes of all things tech from the largest companies to start-ups to venture capital funds. The tech decline has been encapsulated by the 22%[ii] drop in the tech-heavy NASDAQ index.
The last few months have not been easy, but they’ve been a whole lot better for those investors who have stuck with patience and discipline to a broadly diversified portfolio as part of a long-term financial plan.
The markets have once again passed judgment on high-risk, speculative investments made at a time of high investor exuberance. The verdict? It’s no way to build your wealth.
[i] S&P Dow Jones Indices
[ii] YCharts.com