In times of crises, market commentators have a tendency to focus on the worst-case scenarios imaginable. Recently, I saw the term ‘Greater Depression’ used by a major media outlet – the comment was made in relation to an economic recession the writer believes could be triggered by Covid-19. This is a bold assertion to make. After all, the global financial market is a complex entity. Nothing is ever certain, which is why any projection or forecast needs to be put into perspective.
The reality is that Covid-19 has investors and traders worried. This is because there are so many questions surrounding this health crisis and when it will be resolved. Dare I say it, based on recent reports we might have already passed the peak of the pandemic, at least here in the UK? But there is nothing to suggest a second outbreak or spike in cases is off the table. All scenarios are possible, though we should remember that some are more plausible than others.
The stark choice
For the moment, investors are left with two choices. The first is to hold on their existing assets and hope that any loses will be recuperated as part of the post-pandemic market recovery. This approach appeals to the more conservative investors – those who prioritise security, liquidity and long-term gains with minimal risk exposure. The second is a radical restructure of their financial portfolio, selling off underperforming assets and identifying new opportunities. Due to the inherent risk involved, this is best suited to aggressive investors who favour profitability over security.
There are many factors to take into consideration when making the above decision. One of these is understanding how different asset classes are performing in reaction to Covid-19, and whether they look set for further gains or loses. Based on what I have seen transpire over recent weeks, there are two interesting observations investors should take note of.
Gold and Covid-19
Gold and precious metals are traditionally considered safe haven assets. This is because regardless of what short term shocks the markets may encounter, these assets are able to hold their value and historically make relative gains, even when inflation is high. They enjoy constant demand due in part to their tangible qualities. Based on this principle, we would expect the price of gold to be steadily rising as investors seek to balance out losses made on the stock market.
Interestingly, this has not entirely been the case. Prices are rising, but the market’s attitudes towards gold is changing. At the beginning of the year, demand for gold increased as a result of US actions in the Middle East. The threat of growing regional instability had investors worried. And while the situation did eventually de-escalate, the outbreak of Covid-19 once again made gold an attractive option.
Just when major governments around the world were beginning to implement self-isolation measures in a bid to stop the virus outbreak, the price of gold suffered significant loses as a result of intense selling. Prices have since recovered and could soon be hitting record highs. This could make for an attractive investment given the stock markets are still in a volatile state of trading.
As with any trade, the challenge is determining when the appropriate time to buy gold is. A useful tool is the Volatility Index (VIX). This index provides a 30-day projection of the expected volatility likely to be experienced in the major markets. Watching the VIX closely, we can see that when there is a drop in the VIX, the price of gold rises soon thereafter. By understanding this basic principle, one can use the VIX to determine when they should be entering (and leaving) the gold market.
Don’t write off the stock market just yet
In the UK, January proved to be an exciting month for the FTSE. Investors were rallying to UK-based assets in response to the so-called ‘Boris bounce’. After years of political uncertainty, it looked as though progress was finally being made on Brexit and this was optimistically received by the markets. By the end of Q1, the FTSE 100 had experienced its worst quarter since 1987. Fears of a recession had forced a mass sell-off, and this was exacerbated by the general uncertainty surrounding Covid-19. As a result, the FTSE 100 was classed as being a bear market – a situation where stock prices drop by 20%.
Now, over one month into Q2, resurging investor confidence has resulted in surging stock prices. On 29 April, the FTSE 100 rose past 6,000 points on Wednesday, which symbolised a 22% gain from the low of 4,993 recorded on 23 March. For investors and traders, a 20% recovery means the FTSE 100 has become a bull market. This is remarkable for two reasons. First, this was the shortest bear market in the FTSE’s history. Second, it shows that investors have not lost confidence in UK-based assets. There is a clear appetite for UK shares, which means any post-Covid-19 recovery could be swift.
In general, the stock market should not be overlooked by those considering a portfolio restructure. Economic crises can result in shares dropping below their market value – this is more of an immediate reaction as opposed to a long-term trend. As a consequence, stock prices will generally recover as confidence returns to the market. The FTSE has a strong track record when it comes to recovering from economic crises, so any undervalued stock is likely to recover once the pandemic is over. The challenge is finding stocks that are well-positioned to recover.
Cautious planning for the future
We live in uncertain times and any forecast for the future is by no means absolute. If the recent performance of the FTSE 100 is anything to go by, it looks as though the market is cautiously optimistic about what the future months could bring. Of course, there are so many unknowns that we could also see any recent gains immediately wiped off the market should there be a second outbreak of the virus or a severe drop in investor confidence.
For the moment, I do believe there are opportunities to alter one’s portfolio depending what the ultimate objective may be. However, I would advise investors to tread carefully – we are not even halfway through 2020 and there’s no telling what could lie on the horizon, positive or negative.
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