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The stock market rally might not last. Here’s what I’m doing

The huge bounce in markets over the last couple of weeks has been almost as sensational as the crash that preceded it. By the close of play yesterday, the FTSE 100 and FTSE 250 were up 14% and 19% respectively, since the lows of 23 March.

UK investors seem optimistic again, bullish even. I’m not quite as confident.

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Why so serious?

Don’t get me wrong — the fact that some curves are beginning to flatten is clearly very encouraging news. However, expecting the mother of all economic recoveries in double-quick time just doesn’t sit right. 

For one, lockdowns will be lifted gradually and perhaps reinstated. Non-essential businesses will remain shut. Regardless of how much stimulus the government throws at the problem, further pain is inevitable. Many jobs perceived as ‘safe’ could still end up being lost. 

As investors, we also need to think about this from a psychological perspective. Will people feel as secure in their jobs (assuming they still have one) as they once did? Aside from the odd ‘treat’, will they be likely to go on a spending splurge once the restrictions are lifted? Even if they are in the fortunate position of having no financial concerns, will members of the public be rushing to, say, sit in a plane or a cinema? I’m no so sure. 

So, don’t buy at all?

I wouldn’t say that. Having fallen so far in 2020, stock markets arguably offer a better risk/reward trade-off than before. As long as you intend to hold for a long time, continuing to buy cheap index trackers or diversified active funds feels logical. We Fools invest for years and ideally, decades. If indices are still below previous all-time highs in 20-30 years time, we’ve probably got bigger things to worry about.

Things get a lot more tricky, however, when we focus on individual companies. Remember that some won’t be making a penny of revenue at the moment. As such, traditional methods of valuation, such as the price-to-earnings (P/E) ratio need to be used with caution.

Take Cineworld as an example. Its share price rose 49% yesterday after its dividend was scrapped. Is the company 49% more valuable than it was on Monday? I’d argue not, simply because the earnings outlook definitely hasn’t improved. Consequently, wild share price moves like this don’t inspire confidence. 

This is not to say that that all individual company stocks should be avoided, but I think it requires investors to be even more fussy than usual. Only high-quality companies should be making the cut, in my view. Firms with sound finances, strong management and competitive advantages will, after all, always be those most likely to help investors grow rich over time. 

I could be very wrong

I’m no more informed about the future market direction than you (although I’m very confident the long-term trend is most certainly up). Notwithstanding this, I’m sceptical that the recent surge can last.

So, I’m hedging my bets. If share prices keep rising, I’ll be happy because I have some money invested. I’ll celebrate because I didn’t panic and sell everything as coronavirus raged across the world. If they continue falling, I’ll have some dry powder to take advantage and buy.

Bear markets last roughly a year on average. We’re only one month into this one. I’ll continue to tread carefully while watching out for solid opportunities.

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Paul Summers has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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