Imagine walking into a casino. You are warmly greeted by its owner who gives you a wad of cash and tells you to put it all on black. You take his advice and leave at the end of the evening considerably richer on the back of someone else’s money. This is kind of how the US stock market feels to me right now.
Despite the International Monetary Fund coming out and saying that the world economy faces its worst crisis since the Great Depression; despite over 16 million Americans filing for unemployment insurance in recent weeks; despite major US banks saying that loan losses are likely to be worse than in 2008 and despite fund managers having their lowest equity allocations since March 2009 (the last major stock market bottom), the S&P 500 is staging an incredible rally.
It seems as if the US stock market and the real world are worlds apart. Big brokers are bullish with some predicting that the market will reach record highs again within the next year, mainly because of all the money the Federal Reserve has thrown at it and that the economy will soon get back to normal again and bounce back strongly.
Nobody knows how fast and by how much the economy will recover but if the bulls turn out to be correct then surely a good deal of this outcome is already priced in.
UK economy to get hammered but is expected to bounce back
This week saw the Office of Budget Responsibility (OBR) give its view on what the impact of the current UK lockdown will be on the economy. In short, the OBR thinks it will be hammered.
It has based its view on a three month lockdown of the UK economy and then assumes that it will take another three months for things to get back to where they were before. It estimates that this will cause the UK economy to shrink by 35 per cent in the second quarter of 2020 and by just under 13 per cent for the year as a whole.
However, it also seems to think that things will get back to normal very quickly and that the economy will start growing at the same rate as was expected in the budget. This is the “V” shaped recovery that so many people are talking about - and hoping for - right now and is the best case scenario according to the OBR.
In many ways, the principles of good investing have not changed in the current turmoil. Business quality should always be the most important consideration of any investor and is more important than valuation.
As we have seen, cheap shares have become cheaper but the high quality businesses with more robust revenues and profits are still very expensive, and too expensive to buy now in my opinion.
The UK stock market is a difficult hunting ground at the best of times but the shares I mention in this week's round-up are good businesses in a most difficult sector. The bonus is that their valuations seem to offer attractive risk-reward trade offs, which are few and far between right now.
Download PDF
