The economy’s outlook is highly uncertain at the moment. Data such as the consumer confidence index has declined materially over recent months. According to the index, consumer confidence is now at a six-year low. Therefore, even though improving investor sentiment has pushed the S&P 500 over 40% higher since the March lows, a challenging economic outlook could be ahead.
Famous fund manager Peter Lynch has invested through several difficult economic periods in his career. His preference for investing in dominant businesses and holding them for the long term could be key reasons for his 29% compounded returns between 1977 and 1990.
Dominant businesses
A challenging outlook for the economy means that only the strongest businesses in some industries may survive.
Therefore, it could be more prudent to purchase shares of companies that have low leverage and wide economic moats, as they stand a better chance of surviving a period of weak sales performance. They may even extend their market share via weaker businesses that go under.
Dominant businesses that have wide margins of safety may currently exist in industries where investor sentiment is weak. For instance, investors may view the leisure sector as being unattractive at the moment. This could mean that dominant businesses in that industry offer good value for money. As Lynch once said, “In business, competition is never as healthy as total domination.”
Diversification
Diversifying your portfolio can help to reduce risk. It may be particularly effective during a period of economic turmoil when it is naturally more difficult to make an accurate assessment of the trading conditions facing many companies.
However, holding an excessive number of stocks that you have not had time to thoroughly research for the sole purpose of diversification may not be a profitable strategy. As Lynch once said, “Owning stocks is like having children -- don't get involved with more than you can handle.”
Holding cash
A difficult economic period may convince some investors that holding cash is a better idea than investing in stocks. This may be an increasingly common standpoint following the stock market’s recent gains, with some investors likely to be considering taking profits on their purchases from earlier in the year.
However, low interest rates and a poor track record of performance versus inflation mean that cash lacks appeal over a long-term time period. Although cash may offer less risk than stocks in the short run, holding quality companies for the long run is much more likely to yield high returns. As Lynch once said, “In the long run, a portfolio of well-chosen stocks and/or equity mutual funds will always outperform a portfolio of bonds or a money-market account.”
Identifying the best stocks
Finding the most attractive investment opportunities during a period of weak economic growth may be relatively difficult. You may need to search across a wide range of sectors and spend longer than usual on assessing the fundamental strength of a large number of companies.
However, spending additional time searching for the best stocks and industries could pay off in the long run. As Lynch once said, “The person that turns over the most rocks wins the game. And that's always been my philosophy.”
Read more here:
- Does the S&P 500 Have Investment Appeal After Its 40% Rise?
- Benjamin Graham on Risk Versus Reward
- Seth Klarman on Seeking Value in a Rising Market
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