Investing in a Financial Downturn

The world is in lockdown. The knock-on effects of the coronavirus have devastated the financial markets. With global recession on the cards – possibly even depression – investors are casting around looking for safe havens. Everything is in flux.

Some sectors have been hit harder than others. As the majority of people stay home to self-isolate the roads are empty, and holidays and business trips have been cancelled. The aviation industry is in dire straits and dependent on government bailouts to survive. 

As a result, we’ve seen the lowest oil prices for almost two decades, with potentially worse to come. In the space of three months, some oil majors’ stock market valuations have halved.

But there’s no need to panic. 

In Every Crisis There’s Opportunity

There are always ‘Black Swan’ events that cause chaos in the markets. Black Swan investing is a trading philosophy based on the probability that some unforeseen event will hit the markets at some point. 

A theory popularised by Nassim Nicholas Taleb in his book Fooled by Randomness, the Black Swan is a risk that you cannot determine or predict – but it won’t necessarily have purely negative consequences. 

As the economist John Kenneth Galbraith wrote: “There are two kinds of forecasters – those who don’t know, and those who don’t know they don’t know.”

You might not see the crash coming, but what you can do is build a well-diversified portfolio to reduce the risks.

According to Stephen Moss, founder and MD of property investment company Sourced Capital: “Investment has taken a hit, but while times are tough at present, crisis always presents opportunity when the dust does settle.

“Investing should always be done with a long-term view and across a variety of categories to maximise profitability and reduce risk.”   

So What Should You Be Looking For?

Aswath Damodaran is a professor of finance at the Stern School of Business in New York, and has been analysing the markets weekly since the crisis took hold. He highlights two different approaches based on whether you think the economic recovery will be quick, with little structural damage, or whether you expect a more severe downturn.

If you’re expecting things to recover quickly, Damodaran says, focus on investing in companies whose share price has plummeted recently – but beware of companies carrying excessive debt, which may not survive. Focus on profitable businesses.

Or for those not so risk averse, you could adopt a more scattergun approach. This is far riskier and you’re more likely to lose money. Look for the truly distressed companies on the verge of collapse. If you’re expecting a rapid recovery, by investing at rock-bottom prices you could turn a quick profit – provided the recovery is quick enough to allow them to survive.

If you’re more pessimistic, you could do worse than follow legendary investor Warren Buffett, who famously said: “Whether we’re talking about socks or stocks, I like buying quality merchandise when it is marked down.” 

In other words, adds Damodaran, look for profitable companies – the blue chips – who are in a strong competitive position but whose price has fallen. Invest and hold, and with time you should be rewarded.

Some of these blue chips, such as Coca-Cola, Colgate-Palmolive and Procter & Gamble have also paid dividends for more than 50 years running.  

Growth Areas

Alternatively, if you expect the pandemic to lead to long-term structural changes, you could invest in growth areas, such as remote working. 

The share price of video conferencing company Zoom has doubled since December last year, even taking into account a fall after it was revealed it had security issues. The price of remote working provider Citrix is up by a third compared to a year ago.  

Colin Melvin, at Arkadiko Partners, a consultancy advising some of the world’s biggest investment management and pension funds, said that when things start to recover he expects investors to look at companies perceived to offer wider social benefits.

That could mean companies such as the electric car and battery maker Tesla, which is far less fossil fuel -dependent than traditional car manufacturers. 

Playing it Safe

Unless you’re a habitual gambler prepared to risk it all, nearly everyone agrees that without knowing what the economic situation could look like in six months, let alone a year, now is the time to play it safe.

As well as focusing on blue chip stocks, it’s a good idea to look at essential items that people will need no matter how bad the economy gets. That means food and drink companies, some household good manufacturers, and, if you have no moral objections, tobacco and alcohol.

It could also be time to look at housing. Prices tend to fall during a recession so you could buy at a low price now and sell for a profit when prices rebound as the economy recovers. While you’re waiting for that to happen, you can rent the property out.

Since the last financial crash, London house prices have increased at almost double the UK average, at 83%, while outside the capital house prices in Cambridge have risen by 79.4%. 

Then there is one of the oldest safe havens of all: precious metals. During periods of uncertainty and recession, gold is well known for holding its value. Less well-known precious metals too, such as palladium are also seeing a resurgence.

Government bonds, also seen as a safe haven in a crisis, are a possibility, despite their steep fall in March. That is thought to be down to traders liquidating assets to get their hands on cash to cover losses on other investments. As bonds are some of the most liquid markets (plenty of buyers and sellers) they were the first place the traders turned to.

One thing’s for certain: there’s no rush to invest. No one knows how this is going to play out. Whatever the situation, there is always going to be uncertainty and it is those who invest with a cool head that will reap the profits.