The Second Wave is right here at the doorstep.
Just this week, the UK prime minister Boris Johnson, flanked by chief medical officer Chris Witty and chancellor Rishi Sunak, announced a new three-tiered lockdown system. Sitting at Level 1, the strictest, is Liverpool.
A local lockdown, the PM explained, is necessary to break the chain of infections and ‘suppress the virus where it is surging’. A quick overlay of the daily covid death and FTSE 100 some correlation (see below). Higher deaths result in more market uncertainty.
Against this backdrop of drastic policies and volatile economic outlook, what can investors do to survive the next six months?
Source: UK Government
Investing is about survival through the hard times, so that we can prosper during the good times. As the second wave threatens the UK economy, perhaps it is time to switch to survival mode and play defensive. When analysing your portfolio, ask these essential questions:
- Do you really need this level of risk? Can your portfolio withstand another large percentage loss? If not, ‘sell to the sleeping point’ is the most appropriate action to take now.
- Can you take advantage of a correction, if and when it happens? If not, why?
- Is your portfolio diversify enough? Do you have a counter-market position like gov bonds to balance out the downside market risk?
Events that investors should be keeping an eye on
Prepare for a second UK national lockdown
As covid cases, hospitalisation, and deaths increases, a second national lockdown looks increasingly likely. This will deal the hospitality industry a huge blow. Stocks that have not recovered during the April-September rally are unlikely to do so in the winter months.
Airlines, hotels, transportation, restaurants and pubs, retailers have all suffered greatly due to movement restrictions. This is likely to continue as long as the virus is spreading like wildfire. Look at Easyjet (EZJ). Its share price is about to fall through the floor. Avoid these weak sectors for now due to their bearish price actions.
Prepare for the US election (Nov 3)
Four years ago, Donald Trump upended the political world by capturing the White House. Can he repeat ’16 victory? Recent market predictions, if they are accurate, portray a decisive Democrat win. One latest Guardian poll shows a 17-point lead for Joe Biden; another, by RealClearPolitics, shows a widening gap between the two candidates (see below). However, as Michael Moore pointed out a few weeks ago, support for Trump is ‘off the charts’.
Either way, investors appear sanguine about the outcome of the election. Just three weeks before the polls open, the S&P 500 is trading near its all-time highs. Perhaps investors are already pencilling in a Biden win. Thus will another Trump victory cause a sharp meltdown? Last I checked, the VIX index is sliding into new multi-week lows. Perhaps it is time for hedge for political volatility?
Prepare for Brexit – and a last-minute deal?
The transition period ends on December 31, with no extension possible. Leaders on both sides have struggled to find common political ground. A self-imposed October 15 deadline by the UK prime minister is all but impossible to meet.
The market is not perturbed – yet. Sterling has corrected somewhat in autumn but most investors are still anticipating a deal in the weeks ahead. But it will be a tight race. As the pressure ratchets up, negotiation will drill into a ‘tunnel’ phase to hammer out an economic treaty. The stakes are high. Businesses are weak, and the economic recovery fragile. In the end, a binary finale awaits. It’s either a win-win or lose-lose situation. A Hard Brexit will damage all concerning economies. Thus the GBP volatility is likely to rise into the new year.
Prepare for a potential market correction
After a strong rally, US stocks are undoubtedly expensive. The latest IMF report (October 14) shows these important charts:
The key chart is showed on the right. Broadly speaking, the Price-to-Earnings ratio is a multiple of share prices against corporation profits. If share prices are high and profits low, then PE ratio is high and this means the market is ‘expensive’. In contrast, if share prices are low and profits high, the PE ratio is low. The market is ‘cheap’.
Look at the US. The overall PE ratio has risen to its highest level in years. After a six-month rally, the US stock market is very expensive. Investors are buying stocks in anticipation of a ‘V-shaped’ recovery – which may or may not materialised.
When a market is expensive, future long-term returns are likely to be low. I suspect the probability another 6-month monster rally, like the one we saw during Mar-Sep, is unlikely. Therefore, cash positioning may be warranted in anticipation of a potential correction.
Related Guide: How to profit from the market weakness
Prepare for a recovery in 2021
The pandemic impacted different countries differently. Better equipped countries emerged from the pandemic faster and suffered less economic loss. This means some countries could grow faster in 2021.
Indeed, China, the second largest economy in the world, is reportedly growing faster than expected. Its September import data, year-to-date GDP, and the general economic indicators all point towards a healing economy. No wonder China’s domestic stock market hit $10 trillion this week for the first time since 2015 (see below).
Consider investing in post-covid winners like China and some other Asian countries as they are able to grow faster when the pandemic subsides. There are many investment trusts in the UK investing in these markets, like Fidelity China (FCSS).
Related Guide: How to profit from the covid winners with investment trust
Prepare for negative interest rates in the UK
The Bank of England is looking to implement negative interest rates. (see earlier GMG post about negative rates) Sam Woods, deputy BoE governor and CEO of Prudential Regulation Authority, recently published a letter (Oct 12) asking for clarification from CEOs how they intend to deal with negative rates. In particular, he requested “specific information about your firm’s current readiness to deal with a zero Bank Rate, a negative Bank Rate, or a tiered system of reserves remuneration – and the steps that you would need to take to prepare for the implementation of these.”
The central bank does not undertake these surveys lightly. Therefore, investors must expect some form of negative rate implementation over the six months. And in this context, investors are not enthusiastic about bank stocks.
Barclays, Lloyds, RBS, and HSBC are still trading deep below their 52-week highs (see below). Is the sector cheap? Undoubtedly. But should one bargain hunt here? Not yet. Wait until the sector stabilises itself on the downside. For now, the path of least resistance is still down. Confidence is low as investors are foggy about the earnings impact of the negative rate regime.