The FTSE 100 is nearly back in a bull market – does that make sense?

UK stocks are, technically at least, almost back in a bull market. But with the economy on hold and the prospect of harder times to come, is this rally sustainable? John Stepek explains what it means for your investments.

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The FTSE 100 is very close to entering a bull market. Even writing that sounds daft. And it does show how silly it is to take these informal definitions too seriously.

But if you choose to describe a “bull” market as a stock market index that is up 20% from its most recent lows, then yes, that’s almost where we are. So does this make any sense or are we way ahead of ourselves?

Even the best companies are warning of hard times to come

I have to say, the news from companies so far this week does not inspire confidence in a rapid economic rebound. This morning, clothing retailer Next gave us some idea of just how much havoc coronavirus is going to wreak on the high street. In the 13 weeks to April 25 (Next’s first quarter), sales from physical branches fell by 52%, while online sales fell by just under a third.

That might not sound very surprising given that the company was entirely shut down for part of that period, but Next points out that the extent of the crash was “faster and steeper than anticipated in its March stress test”, notes Reuters. The group now expects full-price clothing sales to fall by 30% this year. That compares to 20% for its previous “worst-case” scenario.

I pay attention to what Next says because it’s an unusually well-run company (full disclosure – I own shares in it). It’s among the best at what it does, and better yet, the management recognises the importance of clear communication and long-term thinking.

The company also has a historic tendency to emphasise the downside, which is smart, because it means you can underpromise and overdeliver. This is a much less stressful way to deal with life as a public company, and yet it’s something that most managers fail to do – most of them favour grabbing short-term plaudits while they can, which is perhaps rational, given the limited time span of your average CEO job.

Anyway, the fact that Next is now revising its worst-case scenario for the year ahead lower might be a classic case of underplaying its prospects. The relatively modest drop in the share price today suggests that the market suspects this to be the case.

And overall, this isn’t as big a deal as it might sound in some ways. Crucially, the company’s financial position is secure, and it will end the year with less debt than it did last year, even under a worst-case scenario, it says. But the point is that this is one of the best-run chains on the UK high street. If things are this bad for Next, then how much worse are they going to be for everyone else?

As AJ Bell’s Russ Mould puts it, “What is concerning for the retail sector as a whole is that CEO Simon Wolfson is normally good at managing expectations. If he was too confident about the coronavirus impact, what about some of the business’s peers, many of which don’t enjoy Next’s inherent strengths?”

Then you’ve got airline IAG (better known to the likes of you and me as the owner of British Airways). We heard yesterday that it’s looking to cut 12,000 jobs – more than a quarter of its global workforce.

The significance here is that we’re moving beyond “suspended animation”. Staff might be furloughed for now, and thus getting paid a decent chunk of their income (particularly if they earn less than £2,500 a month).

But that’s a temporary sticking plaster. Some of these companies are not going to experience a big enough recovery in business to take their staff back. And while the airline industry is very much at the sharpest end of a pandemic (it was the hardest-hit during the likes of Sars) it’s far from the only industry to suffer. And again, like Next, IAG is one of the stronger players in the sector.

This is where investors need to get picky

What’s my point? I’m not saying that markets aren’t justified in rebounding. At the end of the day the level of government support has been spectacular and a lot of companies that might have otherwise gone bust will not.

However, it’s clear from what companies are starting to say that this isn’t a simple matter of putting the economy on freeze and then pressing the “on” switch to get everyone going again.

Some people are going to lose their jobs permanently. The high street’s woes – and therefore the plight of commercial property landlords, which then kicks on to banks – are only going to worsen. To be fair, this latter is only continuing a process that was already playing out, but that has the potential to be very disruptive.

What does this mean for markets and your investments? On the one hand, the liquidity issues have been addressed by central banks and governments. These have been unprecedented and the overall impact is that most companies and individuals should not go bust for lack of access to short-term money. In other words, if you have a viable business that has been damaged in the short run by no one going out, then it should survive in the short term.

The question now is the solvency issue. Overall consumption will be lower for some time – not because we all became monks during lockdown, but because some people just won’t have as much disposable income anymore. We already had overcapacity in a lot of the retail and leisure markets – that’s going to unwind harder now.

Which industries and individual stocks are most vulnerable to that, and which will be the survivors? That’s probably the main question any stock picker needs to ask themselves now. In this sort of environment, you probably want to stick with the quality companies in the hardest-hit sectors. When overcapacity is being swept out, the companies that benefit are the best-run ones, because in the long run, they have less competition.

Anyway, this is a topic that will run and run. Merryn and I discussed how the recovery might unfold in our latest podcast, which will be out later today. And if you’d rather hear something a little more upbeat, you should listen to Merryn’s podcast with Pictet’s Luciano Diana.

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