Recent weakness in financial markets makes me nervous because I already hold shares. It always does when theres a market pullback Ill never stop feeling like that no matter how long I carry on investing.
However, Ive been investing long enough to know that my best investments start when I buy atlower valuations, when theres fear and anxiety in the air such as right now.
Why Im avoiding the FTSE 100
Ive written before about why a FTSE 100 index-tracking fund is unappealing. Atracker fund allocates investmentsby weighting, sotoo much of my FTSE 100 investment would go to large, mainly cyclical firms. To me, the most promising firms in the index reside among the 70 smallest constituents, and a weighted FTSE 100 index tracker would only allocate about 30% of my funds there. That seems like a missed opportunity and a risky strategy.
Weve seen collapsingshare prices of commodity firms and oil companies lately with big banks not far behind. That raises the possibility of a contrarian approach with the aim of catching the next upleg forthese highly cyclical sectors. Yet investing in the cyclicals is problematic, and misjudged timing can hammer a portfolio. I agree with ace fund manager Neil Woodford who wrote that were likely to see a lot of dividend carnage this year and beyond. When I see dividend yields of 8% and higher, as now with some of the big banks, oilers and miners, and particularly when those dividends arent fully covered by earnings, I cant help thinking they have slice me, dice me written all over them.
However, a trimmed dividend isnt necessarily a bad thing for cyclicals. Stock markets look forward, beyond immediate macroeconomic concerns, and the share prices of cyclical firmscould move up even as the directors cut their dividends. In fact, it could take a dividend cut to catalyse a change in trend for the cyclicals perhaps investors will see it as a signal that the worst is behind the firm in the current cycle and earnings could then begin to recover. I rememberAviva rocketing skywards a few years back when it cut its dividend.
What I would buy
Im not keen on revisiting the cyclicals yet though. Its hard to judge the timing of an investment in them, and to my mind we dont have a clear enough signal that economies are going to tank completely around the world. Because the signal isnt loud enough, its possible the cyclicals could charge lower still if the general economic outlook worsens, and I dont want to risk my capital gambling on that.
Instead, Im likely to use the current market sell-off to focus on the smallest 70% of firms in the FTSE 100 index with an emphasis on businesses with defensive characteristics. Firms with as little cyclicality as possible inherent in their business models could make good investments, particularly if their share prices are dragged down with the wider market. In particular, Im thinking of consumer goods firms with strong cash flow due to a product offering that customers tend to use and repeat-purchase, whatever the economic weather. Cleaning products, foods, personal care, tobacco products, alcoholic drinks, and medicines fit the bill. There are also some good cash-generating and evergreen businesses to be found in the utilities, defence, and technology sectors.
Kevin Godbold has no position in any shares mentioned. The Motley Fool UK owns shares of and has recommended Apple. We Fools don’t all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.