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Be prepared for more market jolts as the recovery rally comes under pressure
Markets have just experienced more than a week of declines (8-15 June) as investors worried about a second wave of coronavirus infections and deaths.
While Donald Trump’s mooted $1trn infrastructure plan put a spark back into stocks on 16 June, the recent sell-off acted as a much-needed reality check.
There is no reason to panic despite share prices going through a bad patch. Stock market recoveries rarely travel in a straight line and as we’ve discussed several times in the past few weeks, the recent equities rally had gone too far versus the outlook for corporate earnings.
OVERSOLD AND NOW OVERBOUGHT?
The list of best performing sectors during the recovery in late March and April included oil services and travel and leisure. Both these sectors face considerable uncertainty for the rest of the year and beyond, yet investors seemed happy to bid up the stocks.
Interestingly they have been among the worst performing stocks since the market soured on 8 June, suggesting there is now a rotation and that people are taking profits.
Investors also seem to be crystallising gains on biotech stocks following an impressive rally year-to-date. We wouldn’t be surprised to see a similar rotation out of small cap mining, oil and gas shares as well, which have been another strong part of
the market during the recovery period from late March to early June.
These parts of the market may have rallied in recent months, but a more volatile period ahead would warrant owning more defensive and higher quality (which includes financial strength) investments rather than speculative ones.
Also having some spare cash to hand might give you an advantage to buy great companies at lower prices if markets do experience another correction driven by renewed Covid-19 fears.
Key to any second wave of coronavirus is how quickly affected locations can reimpose lockdown measures. The initial data confirming a second wave is likely to shock the market, but a rapid response could reignite the optimism over economic recovery that we’ve seen in recent months, also helped by central banks throwing everything they’ve got to support markets.
It is important to stay alert in the coming weeks and months because there could easily be more jolts in the market.
For example, many companies are likely to say they are still struggling despite reopening for business which might not be good for sentiment towards economic recovery.
It seems plausible that public transport systems won’t be able to function efficiently from a social distancing perspective once more people are encouraged to return to work. There is also the risk that unemployment creeps up as governments withdraw furlough and similar job support schemes, and many companies find they need to trim staff numbers. These negative factors would act as a dampener on investor sentiment.
From our perspective a W-shaped recovery looks increasingly more likely than a V-shaped one. Other experts believe we could see a tick-shaped recovery a bit like the Nike logo, implying a slower rebound.
Whatever happens in the coming months, expect a bumpy ride but don’t lose faith with your shares, funds and bonds. Stay invested and be patient as the world will eventually get through the crisis.