From mid-March until late April, the FTSE 100 index staged an impressive 20% bounce-back. This came after tumbling by more than 30% in the depths of the stock market crash.
Since then, the index has pulled back some of its gains, falling by 5% over the last few days. Analysts were left scrambling for explanations to account for soaring stocks and increased investor confidence that saw the index have its second-best April in a decade.
Truth be told, it’s difficult to explain why the FTSE 100 is up 15% since the crash. Especially amid the unprecedented challenges that face the world economy. So is now a good time to buy UK shares?
Out of touch with reality
Many investors argue that the stock market has become out of touch with reality. The rise in share prices across the board in April doesn’t seem to correlate with the concerning state of the global economy. Moreover, an array of economic data and statistics seem to back this up.
For example, two weeks ago, the Office for Budget Responsibility (OBR) released a report on the economic impact of Covid-19. It forecast a 35% contraction in real GDP and a rise in unemployment by over two million to 10%. In my opinion, that’s an entirely plausible scenario. Especially in light of worldwide disruption to supply chains, high levels of unemployment claims and an overall decline in output.
However, could it be that the stock market has already factored this in? After all, the very same OBR report predicted a quick bounce-back in real GDP and employment that could result from a relaxation of lockdown restrictions and a swift return to business as usual. If this is the case, now could be a great opportunity to buy cheap UK shares.
What’s next?
At the same time, I’m wary that UK shares could plunge further. In a worst-case scenario, the market could experience a bumper sell-off in response to weaker earnings forecasts and further uncertainty with regards to the macroeconomic outlook.
Ultimately though, nobody knows what a new week may bring. That’s why I’d encourage investors to exercise caution in this uncharted stock market territory, having a long-term strategy to mitigate the short-term volatility in the stock market.
Invest cautiously
Until a few days ago, the FTSE 100 gains of recent weeks were enough to qualify as a new bull market. However, hopes of the run continuing were dashed on Thursday when the index slumped back below 6,000.
With that in mind, I’d be cautious when investing in shares, but I’d still do it. How? I think ‘defensive’ stocks, such as healthcare giant GlaxoSmithKline or British supermarket chain Tesco, may be a good place to start if you’re sceptical about a swift economic recovery.
Alternatively, you may be bullish about the survivability prospects of certain companies trading on dirt-cheap valuations. In that case, airline stocks such as easyJet or IAG could be a strong buy. The two companies P/E ratios sit at 6.8 and 2.2, indicating significant value if cash and liquidity remains strong enough to see them through. But they’re not for the risk-averse.
Crisis-ridden banks such as Barclays and Lloyds could offer the prospect of attractive returns long term despite a sustained hit to profits. I think they have the cash reserves and balance sheets to do so, in which case investors can expect decent returns.