My colleague Michael Baxter made a compelling argument last week, concluding that “the 2020 coronavirus economic shock is likely to be sharp, but short.”
I think he’s right. My guess is that the pandemic will peter out and economic activity will rebuild across the world.
How the FTSE 100 bull could follow the bear
If the stock market takes that view, we are likely to see a change in trend for many shares as they begin to stair-step back up again. And they’ll probably start that up-move when the coronavirus news flow still seems bad – perhaps even when it’s at its worst. Why? Because the stock market is forward-looking and driven by the minds and thoughts of all the individual investors participating in it.
Meanwhile, the falls in this bear market are playing out just as they ‘should’. For example, stocks backed by defensive underlying businesses have generally fallen the least. I’m thinking of FTSE 100 names such as AstraZeneca, British American Tobacco, National Grid and Unilever.
But shares backed by cyclical enterprises have fallen much further because they tend to suffer the most during a general macro-economic slowdown. I’m thinking of FTSE 100 names such as Lloyds Banking Group, BP, Carnival and Burberry.
And my recovery watchlist is packed with both types of company. Defensives, because they’ve shown a degree of resilience under the current tough market conditions. My hope is they’ll continue to perform strongly when the next bull market arrives.
What’s on my watch list
But I’m also adding cyclicals to my list. It’s true that those stocks are down for good reasons. It seems likely their profits will collapse during the economic disruption caused by the pandemic. However, cyclicals can be good vehicles for riding an economic recovery when their operations begin to recover. And if you remove coronavirus from the equation, we will probably see swift recovery in many areas of the economy.
I’m confident that coronavirus will fade over time and that economic activity will rebuild. I don’t know how long it will take, but with patience, I reckon many cyclical stocks could prove to be decent investments in the years ahead.
After the bear market between 2007 and 2009, we saw some mighty share price advances over several years. These came in FTSE 100 sectors such as banking, retail, housebuilding, distribution and others. And it could happen again.
Big could be beautiful
My plan involves first targeting well-known names with large market capitalisations. I want the liquidity that comes with the FTSE 100’s large-cap cyclicals so that trading in and out of the shares is unproblematic.
And one of the key considerations is the strength of the balance sheets backing each business. If a company has low and manageable debts, it will be in a much stronger position to survive a prolonged period of reduced, or zero, profits.
Finally, I reckon that share prices have likely disconnected from the underlying value supported by the fundamentals of their businesses. It can happen in fast bear markets on the downside just as it can happen in raging bull markets on the upside. So I want to make sure a cyclical share has stopped plunging and started its ascent on the other side before buying.
