Investing lessons in 2023 from the dotcom crash and GFC

ONE month into the new year, many investors are looking to turn the page on a turbulent 2022

Last December, the stock market closed out its worst year since 2008, with the S&P 500 sinking 19.4 per cent and snapping its three-year winning streak. Investors took a beat-down in both stocks and bonds, and the rout created a sense of deja vu for investors who have experienced some of the biggest stock market crashes of the 21st century.

Already, many industry observers are drawing parallels between the macro backdrop of 2023 with the collapse in Big Tech stocks reminiscent of the dotcom crash in 2000, while the fallout of the pandemic strikes a chord with the global financial crisis (GFC), which saw global markets under extreme stress from 2007 to 2009.

While history never repeats itself, it often rhymes, as the saying goes. It is clear that as investors look into a murky year ahead, they will not only need to reference lessons of the past, but also develop a different investing playbook for 2023.

Same, same, but different?

Before going into the lessons, we must first set the context.

The dotcom crash and the GFC were both caused by asset bubbles – technology in the former and real estate in the latter – that were primarily driven by easy money and low interest rates. Both times, central banks stepped in to bail out markets by aggressively cutting interest rates and injecting liquidity into markets, allowing them to recover relatively quickly. The stock market during the pandemic presented a similar backdrop, where the market sell-off was followed by corrective rallies, due to the low interest rate environment that led to markets being awash with liquidity.

During each of these recoveries – which I witnessed first-hand after starting my career in the financial sector in 2000 and running a trading desk in Australia during the GFC – I saw aggressive new entrants to the stock market trying to buy the dip, resulting in a massive expansion in equity ownership.

None, however, was more apparent than the retail investor wave that took place during the pandemic. Driven by a significant demographic shift of digitally-savvy millennials becoming new-age traders, along with accelerated digitalisation and the rise in self-directed investment that was driven by remote working trends, trading volumes in the pandemic years were 10 to 20 times higher than in 2001 and 2008.

Another key difference is the wider macroeconomic conditions in which the stock market crashes took place. The dotcom crash and GFC happened during “The Great Moderation” – described as the period of steady growth and inflation in the 40 years before the pandemic – where recession implied lower inflation. This time, however, the current market environment shows signs of an economy under extreme pressure due to macro headwinds such as high inflation and a tight labour market. The market downturn is now being fuelled by efforts such as the overtightening of policy to curb inflation – the first time since the 1980s – leading to corrections in equity markets.

In 2023, investors will need to develop a different investing playbook two decades down the road, and they can do this by first understanding the following lessons that history has taught us.

Knowing what to buy

First and foremost, investors will need to establish what they would like to invest in. A large part of this entails a good understanding of the investments they are looking at and focusing on the fundamentals. In equities, for instance, this can mean examining prevailing tailwinds or headwinds that affect the company’s sector, before turning to its financials and earnings reports to examine the stock’s ability to defend and grow its margins, in the face of tighter economic conditions.

Focusing on fundamentals will also allow investors to steer clear of fad investing, which leverages the “fear of missing out” mentality and refers to the buying of a stock just because it is trending. This is best exemplified by the meme stock rallies of 2020 and 2021, which saw speculative behaviour driving wild swings for investors.

To get a better understanding of what to invest in, investors will need to look further afield for access to different asset classes, sectors, and markets. Especially during uncertain times, there is a need to diversify holdings out of riskier asset classes and move into defensive sectors such as pharmaceutical and utility stocks.

Last year, strong recoveries following the recent corrections were largely driven by various commodity markets, including oil and gold, which rallied sharply despite being flat year on year. Commodities have traditionally been a good hedge against inflation, offering investors the opportunity to diversify away from pure technology stocks that dominate the US equity indices and underperformed during the last year.

Being disciplined

As key macro and policy developments shape investment decisions in the year ahead, investors will need to stay disciplined. At the fundamental level, they would need to do their homework and analysis to decide, firstly, if they have adequate multi-asset diversification to weather equity market volatility; secondly, how to implement stop-loss strategies to protect capital; and finally, if they have too much sector concentration, with the view to avoiding sharp reversals, such as that seen in the tech sector.

Through stop-loss orders, investors can set the maximum potential loss from a trade ahead of time and remove the human error from closing losing positions. Bearing in mind that the markets could still see large movements similar to the 1970s and 1980s, which saw long periods of decline, cutting losses and re-evaluating investment positions will prevent investors from being on the wrong side of the market for a prolonged period.

Further to knowing the entry and exit points of investment, investors and traders will also need to determine the dollar amount that they are willing to risk on an investment or trade. For traders looking to do margin trading, this gives them an idea on how much leverage – or borrowed capital – they are willing to take on.

Experienced traders can also consider alternatives such as contract for differences (CFD) trading, a leveraged product that allows traders to deposit a small percentage of the total trade value to open a position. In addition to buying a stock or “going long”, CFD trading allows traders to hedge their positions by shorting assets such as equities or index markets.

Staying ahead

Amid the volatile markets now, there are many lessons to take away from the dotcom crash and the GFC. Importantly, those wanting to stay ahead of the market will need to be armed with the discipline, knowledge, and skills needed to actively manage each position or holding, instead of being a passive investor.

In order to not only survive but thrive in uncertain times, the new investment playbook calls for investors to exercise discipline and go back to fundamentals.

The writer is head of retail, Asia-Pacific, at StoneX.