We live in weird times. The coronavirus pandemic, the lingering Brexit uncertainty, and Fitch’s downgrade of the UK’s sovereign debt frighten investors. Many people are panicking but others are looking for an opportunity to invest. For this latter group, the key questions now are ‘What to buy?’ and ‘How to find the stock market bottom?’.
External shocks
The coronavirus pandemic is the focus of attention for media and individual investors. The human toll is staggering, and is stretching medical support to the breaking point. Crucial efforts to limit the spread of the virus are having a dramatic effect on the world’s economy. This translates into lower earnings for the UK’s FTSE 100 companies.
Finding the bottom
Some experts already call this crisis “the great cessation” and believe that it could be brief but very deep.
Goldman Sachs’ Jan Hatzius estimates that Europe’s GDP in the second quarter will decline by a shocking 38% on an annualised basis. However, the timing of the recession very much depends on the spread of the virus. Some time also has to pass before we see how effective policymakers’ actions to support the economy turn out to be.
Hatzius’s colleague David Kostin still thinks the S&P 500 could end this year 19% above the current level. Still, in the coming weeks, stock investors will experience short-term pain because the market has not yet hit bottom.
JP Morgan’s analysts think that appropriate monetary and fiscal measures, as well as the massive stock market sell-off, almost guarantee a massive stock market rally. In their view, it has just started. Yet, in JP Morgan’s opinion, some risk assets, such as oil securities, might plunge further.
Choosing good quality assets
I would buy great companies with solid fundamentals now, provided they are on sale. As Warren Buffett once famously said, “it’s only when the tide goes out that you discover who’s been swimming naked.” This means that a crisis is often a litmus test for affected businesses.
Thus, the 2008 recession was a moment of truth for banks. The largest and most important financial companies were saved by government. Lloyds and the Royal Bank of Scotland were the major recipients of the UK government’s help.
Survival of the fittest
It seems to me that 2020 will be a similar moment of truth for oil companies. They are so cheap now because of coronavirus travel restrictions and the oil price war between Saudi Arabia and Russia.
The largest profitable companies with sound balance sheets and solid cash flow statements are likely to survive on their own. In the worst case scenario, governments would intervene to save them. The smallest loss-making companies, however, may well go bankrupt. Once this panic is over, the largest companies would recover and flourish, helped by the loss of competitors.
