Making forecasts about the future direction of shares and markets is hard. Faced with a global pandemic of uncertain proportions, it’s next to impossible.
Volatility is sweeping the stock market on a daily basis and it’s anyone’s guess just how far the economic impact of coronavirus will spread.
Some sectors have been sucker-punched by the crisis, such as airlines, leisure and travel. In a few cases, companies are facing a battle for survival. Early evidence suggests that many others are reinforcing their finances wherever they can. Credit lines are being drawn down, dividends and buybacks are being shelved and in some cases staff are being furloughed.
For investors, it’s an incredibly unsettling time.
There’s an old saying (originally by John F. Kennedy, I think) that the time to repair the roof is when the sun is shining. During the decade-long equity bull run that came after the financial crisis in 2009 it was easy to forget the wisdom of being prepared for the worst.
When it comes to managing a portfolio of shares, taking defensive measures in the good times can easily feel like the wrong choice. But here we are in a situation hardly anyone predicted that’s unfolded at devastating speed.
Few will have the stomach to start fixing their portfolios while the storm rages. But in the weeks and months ahead it might be worth thinking about how to be better prepared for any weather in the future. One way of doing that is to consider how diversification can help to avoid the risk of too much sector specific exposure...
Diversification - the only free lunch in finance
The cyclical nature of business and economies means that different stocks behave differently depending on the conditions. It’s worth taking account of this when it comes to building an all-weather portfolio.
If your positions all tend to do well when the economy is booming, then things could get sticky if a recession, economic shock or unexpected global pandemic should suddenly emerge. But equally, if your stocks are all safe havens in times of economic strife, it’s unlikely you’ll get the big upside when the economy takes off.
To understand this better, you can map the stock market based on three main super-sectors: Cyclicals, Defensives and Sensitives. Between them, they account for the 10 main business sectors:
- Cyclicals: Basic Materials, Consumer Cyclicals, Financials
- Defensives: Healthcare, Consumer Defensives,…
