Be Prepared for a 50% Crash in This Decade...

Feb 26, 2018

Ankit Shah, Research analyst

After a long hiatus, your Insider is back at The 5 Minute WrapUp.

And what timing!

Just two days ago, Warren Buffett's Berkshire Hathaway released its 2017 annual report.

I was so thrilled I cancelled plans to meet some friends and I spent the entire weekend scouring through the report.

You may find it a bit crazy. But some of us here at Equitymaster have fond memories of this annual ritual. And the portion that fascinates us the most is Buffett's famed annual letter to his shareholders.

Each year we look forward to hearing the legendary investor's wise words. And Buffett simply never fails to offer great lessons and insights into the world of investing.

So, dear reader, I'm excited to share my biggest takeaway from Buffett's latest letter with you.

But before I take you through it, let me offer you some context.

In 2017, there was a flood of liquidity into the Indian stock markets. And consequently, it turned out to be a fantastic year for the bulls. No single major market correction throughout the year.

Come 2018 and there's a change of market mood. Those who expected the bull party to continue uninterrupted through 2018 have already witnessed some jolts over the last one month.

It's a different matter that our research team wasn't quite surprised. In our view, valuations had moved way beyond fundamentals and a correction was on the cards.

I've also been explaining to my premium subscribers at Insider how the Indian bull run is intricately linked to the global stock markets. In fact, very recently I showed them our big picture editor's Vivek Kaul insightful study about the correlation between the Indian and US stock markets. And how the American consumer and the Federal Reserve will play a decisive role in setting the direction of the Sensex in 2018.

I'll admit I have no clue how long or how deep the market correction will go... and consequently, how 2018 will end.

But what I do know with some degree of certainty is that you should be prepared to face a 50% drop in the value of your portfolio once every decade.

I'm not trying to scare or alarm you. On the contrary, I want to prepare you mentally for such an eventuality. And I also want to show you how despite such extreme dips, equities are still one of the most rewarding and safe asset classes.

Going back to Buffett's latest letter to his shareholders...

Since Buffett took over Berkshire Hathaway 53 years ago, the company has grown and multiplied shareholder wealth by leaps and bounds.

Sample this...

Between 1965 and 2017, while the S&P 500 index registered a compounded annual gain of 9.9%, the per share value of Buffett's Berkshire Hathaway compounded at 20.9%.

It gets even more interesting when you see how that translates into the overall gain during the period.

While the S&P 500 delivered overall gains of 15,508%, Berkshire Hathaway's overall gains stood at 2,404,748%.

But...

This doesn't mean that Buffett was able to predict and avoid every market crash. In fact, in every decade since the 1970s, Berkshire Hathaway has suffered four truly major crashes.

Look at the chart...

The Top 4 Berkshire Hathaway Share Price Crashes

On an average, Berkshire Hathaway's share price crashed nearly 50% in every decade. And despite these crashes, it managed to create phenomenal wealth for its shareholders.

This is the MOST IMPORTANT lesson for every long-term investor.

There will be dips and crashes from time to time. You cannot time them. You cannot avoid them.

So, be prepared to see the value of your portfolio dip by 50% once every decade.

This is not easy. But looking at history and Buffett's personal experience, we can tell you that this would be just a passing correction phase.

Instead of focusing excessively on the price action, set your attention to the long-term value unlocking potential of the underlying assets.

And you don't need to be a magician, mathematician, or rocket scientist to do that. If you don't believe me, I'll let Buffett assure you in his own words:

  • Though markets are generally rational, they occasionally do crazy things. Seizing the opportunities then offered does not require great intelligence, a degree in economics or a familiarity with Wall Street jargon such as alpha and beta. What investors then need instead is an ability to both disregard mob fears or enthusiasms and to focus on a few simple fundamentals. A willingness to look unimaginative for a sustained period - or even to look foolish - is also essential.

While this was my biggest takeaway from Buffett's most recent letter to his shareholders, there were lots of other lessons that I believe are very valuable for serious long-term investors. I plan to share them with my premium subscribers at Insider.

I'm also in the process of zeroing in on my next actionable investing idea. Join me at Insider and get the best cherry-picked ideas from across the Equitymaster research network.

Regards,

Ankit Shah
Ankit Shah (Research Analyst)

PS: For those who don't know, the Smart Contrarian free newsletter is now the Profit Hunter. This transformation is made to bring you bigger, better stock market opportunities. As a first step to that - there's a gift for Profit Hunter readers. A celebratory offer that gives away a free year of access to our best small cap recommendation service. (To go directly to the offer click here.)

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2 Responses to "Be Prepared for a 50% Crash in This Decade..."

sanjeev m sinkar

Mar 3, 2018

i feel crash to the tune of 50% is very high.
of course last crash in yr 2008 was almost 58% in sensex level.and that time we were dependent on
FII in flows.
now if you see SIP book & mf inflows, EPF inflows, insurance money coming to market such drastic drop seems
little difficult.
your comments please.also will be happy if you can share crash in BSE SENSEX which higher than 20% since inception.
last one was from 30000 ( 4 mar 2015) to 23000 level .

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R Parikh

Feb 27, 2018

Good! How about some analysis of the components of crash - into different categories - eg index or non index, small mid or large, industry wise etc etc as to which crashed more & which less across several decades of the past - would that not be interesting & offer good learnings & lessons? Looking forward to the same..

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