There had been a stock market rally this week. Today, stocks have retreated a bit. Should we buy now or wait for a second stock market crash?
Reasons for another pullback
Many investors seem to think that the coronavirus pandemic is already over. Indeed, the UK is opening up next month. Many countries are gradually reopening too. So, the recent stock market rally was likely due to that.
However, there is a high risk of a second wave of coronavirus infections. If that happens, governments all over the world will have to enforce Covid-19 restrictions again.
Even if that does not happen, the world’s economy will still have to face the long-term economic consequences of the recent lockdown. Smaller firms with poor balance sheets will probably go bankrupt. Some people won’t be able to come back to work. As a result, consumption levels will stay low for some time and the economy might shrink further.
As we all know, US-China relations have been in the headlines for a while. Although the trade tensions between these two countries started in early 2018, it seems to me that now the situation is totally different. Some countries are thinking of getting compensation from China for covering up information about the spread of the coronavirus. The point I am making is that it could lead to further volatility and maybe contribute to a second stock market crash.
Another rally ahead?
It all sounds very grim but it should not make long-term investors panic. The FTSE 100 has a really good recovery record. Remember that recessions and stock market pullbacks are highly cyclical in nature. They come and go. Economic downturns are the best periods to increase your investments.
As legendary American investor Warren Buffett pointed out, he tries to be “fearful when others are greedy and greedy when others are fearful“. Buffett, however, keeps a large pile of cash and would probably like to take advantage of the next market pullback. I think that it would be a very good idea to keep some powder dry for the next market crash.
What and how to buy?
I really like the approach adopted by my colleague Paul Summers. It is important to keep some cash ahead of any attractive investment opportunity. But I am against any panic selling. It is also important to stick to “good” investments for a long time. By this I mean big companies with high credit ratings. They must not be heavily indebted and they should have large cash cushions. Moreover, they should be profitable and pay dividends. Once you buy these companies’ shares for your portfolio, you should stay calm and look to buy some more stocks once there is a pullback.
It is crucial to read the news and any market updates in order to spot any new opportunities. But remember not to spend all your cash holdings at once. The truth is that it is really hard to identify the stock market bottom. However, if you own the kind of companies I mentioned above, their stocks will eventually appreciate and you will also keep receiving dividends.
