The FTSE 100 index has made substantial gains over the past six months. In March, on average, the index is 13% higher than last September. Much of this is because of the stock market rally that started in November as the global outlook improved.
However, in the past two months – February and March – the FTSE 100 index has run out of steam. In February, it was actually down by 1.7% from January, on average. In March so far, it is up less than 2% from the month before.
In other words, we are no longer in a stock market rally. If February was an indication of that, I think March’s subdued numbers confirm it further.
Why has the stock market rally stalled?
I think there are a bunch of reasons this has happened. The most obvious of these is that the pandemic is still around. While vaccination is underway at speed, vaccines’ side effects are making news. At the same time, the potential threat of coronavirus variants also exists.
Because of this, we are still in lockdown, which will take a few months to end even as the phased easing has started. This means that we are looking at the second-half of 2021 before a real economic bounceback can happen and possibly another stock market rally.
But in anticipation of better times, the the FTSE 100 index and the broader stock markets started its run-up months ago. As a result, when deciding which stocks to buy, to me the valuations increasingly look high. And this is true even for stocks that are still struggling from the pandemic’s effects.
At the same time, the threat of inflation is beginning to rear its head. Commodity prices were on the rise even last year, with the exception of oil prices, which joined in the run-up in late 2020 as well.
Geo-political stress is making a comeback too, as the western world imposes sanctions on China. This only adds to the existing challenges, including the US-China trade war and the UK and China unable to see eye-to-eye on Hong Kong.
How should I invest now?
I think some of the weight will lift off the FTSE 100 index in April and May as more of the economy unlocks, and hopefully resolutions can be found to existing stressors.
In the meantime, I will avoid stocks that are already looking pricey despite still limited business activity. On the other hand, safer stocks that are somewhat out of favour right now look attactive. Their relative valuations based on the earnings ratio are softer than those for many other FTSE 100 stocks right now.
Two examples are the distributor Bunzl, which among other things, provides face masks and gloves, and accounting software provider, Sage. I think given the nature of their business and their financial resilience overtime, they make good long-term investments.
FTSE 100 miners like Rio Tinto also have relatively lower earnings ratios, and they can continue to benefit from the commodities’ price rally, stock market rally or not.