People who understand and practice the principles of value investing can not only survive a market crash, they can even use it to supercharge their portfolio.

There are plen­ty of intel­li­gent and informed peo­ple, much smarter than I, who are pre­dict­ing a sig­nif­i­cant slow down in the glob­al econ­o­my dur­ing 2020, which could lead to a crash in the Aus­tralian share mar­ket. While I don’t pre­tend to be an econ­o­mist, nor do I care to try to pre­dict the future, I acknowl­edge that the peo­ple who are pre­dict­ing a crash might be cor­rect. If I’ve learned any­thing over the years, it’s that the mar­ket goes in cycles and that the job of the seri­ous investor isn’t to pre­dict them, but to know how to play through them.

Hav­ing been an active and fair­ly suc­cess­ful val­ue investor for the last sev­er­al decades, I’d like to share my expe­ri­ence in how to best pre­pare one­self for a mas­sive decline in the mar­ket. I was for­tu­nate to come out of the last crash quite well, even though I lost some mon­ey in the first 2 years of the GFC, I made it back and more on the upswing in year 3. And here’s what I am doing right now to pre­pare for the next one: noth­ing. Absolute­ly noth­ing.

While I don’t wish for a crash to hap­pen because of the impact it will have on the lives of Aus­tralians, includ­ing my friends and fam­i­ly, as an investor I don’t real­ly have a pref­er­ence for which stage of the cycle the mar­ket is in. The same basic prin­ci­ples I have learned to apply to my invest­ing work just as well dur­ing a depressed cycle as they do dur­ing the boom times. In fact, dur­ing a mar­ket decline, the basic prin­ci­ples work even more to my advan­tage, because I am pre­sent­ed with even more buy­ing oppor­tu­ni­ties than I have dur­ing the boom stages of the cycle.

Here’s what I do during a market decline.

1. Don’t panic.

Stick to the fun­da­men­tals of being an intel­li­gent val­ue investor, which involves using rea­son and log­ic to make deci­sions — not emo­tion.

2. Sell on the three point trend line.

Dur­ing a big cor­rec­tion, the mar­ket has two road­signs: “Car Wreck ahead” fol­lowed by “Mar­ket ral­ly Com­ing Up”. The rule I apply for know­ing when to sell a stock doesn’t change dur­ing a mar­ket crash. It’s exact­ly the same — I sell a stock if it’s price drops below the three point trend line (or if the busi­ness reports a sig­nif­i­cant neg­a­tive change in their finan­cial pro­jec­tions). For­tu­nate­ly, the stocks in my port­fo­lio rarely exhib­it this kind of behav­iour dur­ing nor­mal mar­ket con­di­tions, but dur­ing a crash it is more like­ly to occur to a high­er per­cent­age of my hold­ings. But it’s the same rule in good times as in the bad: sell when the price drops below the three point trend line. Don’t wor­ry if the trend line has you sell­ing after the peak, it’s there for down­side pro­tec­tion. You may even be sell­ing some shares at a loss. That’s OK. You can buy them back lat­er, or replace them with oth­er can­di­dates.

3. Buy good quality companies that are undervalued when their share price is above the three point trend line.

Again, this is exact­ly the same process I go through dur­ing any stage of the cycle. The secret to val­ue invest­ing is to buy some­thing for less than it is worth and wait for the mar­ket to appre­ci­ate its true val­ue. Dur­ing a cor­rec­tion, many more of these oppor­tu­ni­ties will present them­selves. The hard­est part is know­ing which ones to take advan­tage of, but for that, I use my QAV check­list. I try to lim­it my port­fo­lio to 20 stocks at any one time, so I will buy those that get the high­est score on the check­list. Don’t wor­ry about miss­ing the first 20% of the mar­ket ral­ly. The three point trend won’t pick the bot­tom, but it will pick the way up. Hope­ful­ly, this will avoid a dead cat bounce. You’ll know when it is time to buy again, you will have so many oppor­tu­ni­ties and shares scor­ing well on the check­list, that you will be amazed.

4. Take advantage of the low prices to go hard.

Dur­ing a cor­rec­tion, it’s not only the prices that are low — inter­est rates are often also low (of course these days they are already his­tor­i­cal­ly low). It’s a great time to get a low inter­est loan and then use those funds to buy more stocks. Gear­ing a stock port­fo­lio is a risky move for ama­teurs and some­thing I wouldn’t usu­al­ly rec­om­mend, but the best time to buy stocks is when there is blood in the streets. If you have a proven method­ol­o­gy of know­ing which stocks to buy, when to buy them and how much to pay for them, and you are con­fi­dent that your picks will appre­ci­ate, and you have the col­lat­er­al to jus­ti­fy a loan, then bor­row­ing cheap funds to increase your invest­ment cap­i­tal is a sol­id strat­e­gy for tur­bo charg­ing a port­fo­lio dur­ing the rare times when prices are incred­i­bly low.

So that’s my approach to val­ue invest­ing dur­ing a mar­ket crash. Dur­ing the 2008 glob­al finan­cial cri­sis, I used this approach to sig­nif­i­cant­ly improve my posi­tion after the down­turn. Wait­ing for buy­ing oppor­tu­ni­ties after a major mar­ket crash may take time.  Some­times, it’s 6 months, and some­times it’s 18 months. Be patient.

Tony Kynas­ton