In the recently published article The Road to Stock Market Recovery we looked at how previous crises could help to gauge the potential speed of its recovery from the coronavirus and assess how our funds might be expected to perform once momentum is gathered. While predicting when the stock market will hit rock bottom is impossible, our key objective is to safeguard our portfolios and prepare for the recovery. A good military strategist will always plan for different scenarios in order to limit the surprise element of any moves by the enemy. Our opponent today is the coronavirus and we discuss below three possible scenarios and the different shapes a sustainable stock market recovery may take.
Search for predictability
When will my family, friends and I be safe? When can we go back to work? When will we be able to go out with friends? When can we go to a concert again? How long must our savings last before our future financial security is threatened or eroded? A lot of questions, and few answers that give us clear guidance. However, in our search for predictability we can start to set the course:
- With time, we are learning more about the virus plus the benefits and drawbacks of different approaches to suppressing it. We will be better prepared to stave off new waves once the current ones start subsiding.
- As we learn more and understand how to take back control, society will slowly get back to work and some remnants of normality will return, albeit probably at lower output levels.
- And finally, with the approval of therapy (ies) and vaccine(s), we should see a return to socializing as we once knew, albeit with a higher level of consciousness of what invisible enemies can impose on us in the future.
Portfolio positioning during the correction
Our strategy is to have portfolios of stocks that together are weatherproof. In times of corrections the portfolios may be secured by adjusting or selling positions more vulnerable to the current threat. You can read about some of the changes our portfolio managers have made recently in our first quarter reports.
Along with safeguarding the portfolios, it is important to have a good balance of companies that are more resilient in times of recession (e.g. telecom, consumer staples and utility businesses) and those that will do very well when a recovery is on the horizon (e.g. material, industrial and financial companies).
We believe in detailed analysis to guide investment in a selection of strong companies rather than indiscriminately investing in all companies in an index. Being an active fund manager allows us to avoid many pitfalls, especially in times of higher volatility and the threat of companies becoming insolvent or business models failing.
In order to trace the current correction, we have developed a set of scenarios to help us navigate over the coming months. These help us plan for actions to undertake as they unfold. We maintain our library of investment cases up-to-date; these are filled with companies we have researched and know well, many of which we have invested in previously. We have plans in place and will act when the time is right. Although we know that none of these scenarios will play out exactly as we describe below, they act as anchors and help us to stay disciplined and navigate a steady course.
Three scenarios of a sustainable recovery
- The virus will be under control by summer and we see a gradual return to normality. The stock market should continue to rise from here and the recovery will be V-shaped.
- The virus will be under control by summer but a second wave arrives in the autumn. The stock market corrects downward again and the recovery may then be W-shaped.
- We will not see a sustained recovery until a proven vaccine is developed, possibly in the first half of 2021. We will see a prolonged downturn and serious recession with the recovery looking more U-shaped.
Traditionally, the stock market can tell when there's been enough carnage and imbalances are about to be removed in the economy. Equities usually turn to a path of sustainable recovery 6-8 months before we actually see positive data in the real economy.
The week before Easter saw very strong equity markets. Are we in a bear market rally (i.e. we will see the market fall back to new lows), or at the start of a V-shaped recovery? We are doubtful it's the latter, although we are not experts in medicine and read the same news as everyone else. Either way, we will stay disciplined in our approach and be prepared for the recovery, whatever shape it may take.