Last week’s news that the Pfizer Covid-19 vaccine has been successful in trials triggered a big stock market rally. As I write, the FTSE 100 is up by 15% in a week.
That’s unusual. I think this shift in sentiment could mark the start of a much longer rally as the global economy gradually starts to recover. For investors, I think this could be a great opportunity to build stock market wealth and, perhaps, even retire rich.
Of course, there are no certainties, and we may still be a long way from a return to pre-Covid normality. But with testing and vaccines, I think the route back to normal is clearer than it was before.
The secret to success?
US billionaire Warren Buffett once said that “very successful people say ‘no’ to almost everything”. Buffett’s record of only making new investments very rarely suggests he follows his own advice. Even during this year’s crash, the ‘Oracle of Omaha’ has only made a few big trades.
I believe there’s a lesson here for investors who want to buy shares for the stock market rally. I don’t expect all stocks will perform well, even if we do get a strong stock market rally. In my view, the secret to success will be buying the right companies at the right time.
Stocks I’m avoiding
There are two areas of the stock market I’m taking care to avoid. I think investors in these shares could be disappointed over the next year.
One of these areas is US technology. Many of the big tech stocks have delivered a stock market rally of their own this year, generating big profits for shareholders. I think most of these firms will hold on to the new customers they’ve acquired in 2020, but I expect their growth to slow next year. In my view, this is likely to limit further share price gains — at least for a while.
The other sector of the market I’m avoiding are turnaround stocks that have only survived this year by borrowing huge amounts of cash. I’ve written about two such firms recently. Even though these businesses may make a strong recovery, I think shareholder returns are likely to suffer as management will be forced to focus on debt repayment.
Shares I’m buying for the stock market rally
So where am I investing my cash? Firstly, I’ve been looking for UK companies that are out of favour, but in good shape financially.
Typically, these have been consumer goods or industrial companies. Their profits have dipped this year, but they’ve not needed any extra funding and are in good shape to deliver a recovery.
I believe buying shares in these firms at depressed prices will give me a margin of safety. This should provide some protection if the economy remains sluggish for longer than expected.
The second type of company I’ve been looking for are high performers which have historically been too expensive for me to buy. These have mainly been in the financial and technology sectors. Again, I’m happy to be buying these at lower valuations for my long-term portfolio. I think they’ll return to their winning ways when the world gets back to normal.