The uncertain economic and political outlook may deter some investors from buying stocks. They may be concerned about the potential for capital losses in the near term.
However, in my view, economic and political risks can lead to more attractive stock valuations. Wider margins of safety may be on offer that provide buying opportunities across a diverse range of sectors.
Howard Marks (Trades, Portfolio) has previously sought to use uncertain economic and political prospects to buy undervalued stocks. The Oaktree Capital cofounder's long-term view and willingness to buy when other investors are fearful may be key reasons for his consistent outperformance of the stock market.
Low valuations
The stock market's surge since March has largely been driven by rising demand for large-cap technology companies. They have become popular among investors due to their optimistic growth prospects.
However, many other stocks continue to trade at low prices due to an uncertain political and economic outlook. Investors may be avoiding them because they are concerned about the prospect of weak financial performance that may cause further falls in their prices.
In my view, this creates buying opportunities for long-term value investors. Some stocks have fallen to prices that now include wide margins of safety that do not accurately represent their financial position and earnings prospects.
This reduces their investment risk because the market is already anticipating poor performance in the short run. It also provides greater return opportunities as the economic and political situation improves in the long run.
As Marks previously said, "When everyone believes something is risky, their unwillingness to buy usually reduces its price to the point where it's not risky at all. Broadly negative opinion can make it the least risky thing since all optimism has been driven out of its price."
Improving outlooks
Some investors may avoid today's cheap stocks because they feel that their challenging financial outlooks will persist over the long run. For instance, they may extrapolate a company's low level of profitability in the current year over the long term so that its investment prospects appear limited.
However, the recent disappointing financial performances of today's undervalued stocks may not last forever. Sectors that currently face poor trading conditions could be among those industries that benefit the most from a long-term economic recovery.
Therefore, buying quality companies now may mean that you capitalize on their recovery prospects as the economic and political outlook improves.
As Marks once said, "Those who believe that the pendulum will move in one direction forever – or reside at an extreme forever – eventually will lose huge sums. Those who understand the pendulum's behavior can benefit enormously."
Ignoring short-term woes
It is impossible to accurately determine when the financial prospects for today's undervalued companies will improve. They are very dependent on the economy's outlook, which could be impacted by an infinite number of variables.
This means that buying stocks today may lead to short-term losses if economic and political prospects deteriorate. Therefore, adopting a long-term viewpoint could lead to a more efficient allocation of your capital. It may allow you to ignore short-term volatility, and instead focus on long-term capital appreciation as the rate of economic growth improves.
Marks has never sought to find the very bottom of any stock price. Rather, he has accepted the potential for short-term unrealized losses in return for long-term growth potential. As he once said, "A hugely profitable investment that doesn't begin with discomfort is usually an oxymoron."
Read more here:
- Warren Buffett: A 'Dull' Investment Strategy Can Be Profitable
- Benjamin Graham: Ignoring Your Peers Can Pay off in the Long Run
- Seth Klarman: 3 Reasons to Be Cautious in Bull Markets
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